Effects of Corporate Diversification: Evidence From the Property–Liability Insurance Industry

Using a sample of property–liability insurers over the period 1995–2004, we develop and test a model that explains performance as a function of line‐of‐business diversification and other correlates. Our results indicate that undiversified insurers consistently outperform diversified insurers. In terms of accounting performance, we find a diversification penalty of at least 1 percent of return on assets or 2 percent of return on equity. These findings are robust to corrections for potential endogeneity bias, alternative risk measures, alternative diversification measures, and an alternative estimation technique. Using a market‐based performance measure (Tobin's Q) we find that the market applies a significant discount to diversified insurers. The existence of a diversification penalty (and diversification discount) provides strong support for the strategic focus hypothesis. We also find that insurance groups underperform unaffiliated insurers and that stock insurers outperform mutuals.     

Cash holdings between public and private insurers ‒ a partial adjustment approach

Cash holdings of financial institutions, especially private firms, have been understudied in existing literature. This paper fills that gap by examining the cash holdings of US property-liability insurers in order to analyze the difference in cash holdings and cash adjustments between public and private stock insurers and between mutual and stock insurers within the private insurer category. We find that public insurers hold much less cash than private stock insurers, which differs from the findings for non-financial firms. Additionally, we find that mutual insurers hold less cash than private stock insurers. Public insurers adjust their cash holdings much faster toward their target cash levels than private stock insurers do when facing an extreme cash shortfall, but their adjustment speed is indifferent from that of private stock insurers when both having excess cash. Mutual insurers are able to adjust cash holdings slightly faster than private stock insurers when there is an extreme cash shortfall but are indifferent in adjustment speed from private stock insurers when having excess cash in hand. Overall, our results are more consistent with the financing frictions hypothesis of cash holdings and are inconsistent with the owner-manager agency problems of free cash flow.     

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.     

Capital Structure Decisions in the Insurance Industry: Stocks versus Mutuals

Mutual insurers generally face higher costs of raising new capital than stock insurers. Other things being equal, the higher costs of raising capital should cause mutual insurers to have higher ex ante target capital to liability ratios than stock insurers. Mutual insurers' capital ratios also should be more sensitive to income than capital ratios for stock insurers and therefore adjust more slowly toward their long-run targets. We provide evidence concerning these issues using aggregate time series data for stock and mutual insurers during 1984–1999 and a large panel data set during 1991–1998. Our regressions provide strong evidence that annual changes in capital to liability ratios are more sensitive to income for mutual insurers than for stock insurers. We also provide evidence that mutual insurers' capital ratios are on average higher than those for stock insurers after controlling for several factors that could influence capital ratios.     

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.     

Capital Market Development,Competition, Property Rights,and the Value of Insurer Product‐Line Diversification: A Cross‐Country Analysis

In this article, we show that the effect of product diversification on performance is not homogeneous across countries. Diversified insurance companies perform significantly worse than their focused competitors in countries with well‐developed capital markets, high levels of property rights protection, and high levels of competition. In addition, we find that the diversification–performance relationship for insurance companies depends on company size. For large insurers operating in countries with less developed capital markets, diversification significantly increases performance. Our results suggest that the optimal organizational structure may be different for insurers operating in emerging economies than for insurers operating in developed countries.     

Actuarial Surplus Management in United Kingdom Life Insurance Firms

This study uses 1991–99 data gathered from the United Kingdom's life insurance industry to test empirically the notion that the reported annual surplus of a life insurer may be influenced by four firm‐specific characteristics: namely, reinsurance, output mix, organizational form and firm size. Consistent with expectations, the results indicate that the annual reported surplus is positively related to reinsurance and firm size and negatively related to the degree of product diversification. Contrary to our expectations, however, we find no evidence that proprietary (stock) life insurers tend to report higher annual surpluses than mutual life insurers.     

The Client Is King: Do Mutual Fund Relationships Bias Analyst Recommendations?

This paper investigates whether the business relations between mutual funds and brokerage firms influence sell‐side analyst recommendations. Using a unique data set that discloses brokerage firms’ commission income derived from each mutual fund client as well as the share holdings of these mutual funds, we find that an analyst's recommendation on a stock relative to consensus is significantly higher if the stock is held by the mutual fund clients of the analyst's brokerage firm. The optimism in analyst recommendations increases with the weight of the stock in a mutual fund client's portfolio and the commission revenue generated from the mutual fund client. However, this favorable recommendation bias toward a client's existing portfolio stocks is mitigated if the stock in question is highly visible to other mutual fund investors. Abnormal stock returns are significantly greater both for the announcement period and, in the long run, for favorable stock recommendations from analysts not subject to client pressure than for equally favorable recommendations from business‐related analysts. In addition, we find that, subsequent to announcements of bad news from the covered firms, analysts are significantly less likely to downgrade a stock held by client mutual funds. Mutual funds increase their holdings in a stock that receives a favorable recommendation but this impact is significantly reduced if the recommendation comes from analysts subject to client pressure.     

CEO Turnover and Ownership Structure: Evidence From the U.S. Property–Liability Insurance Industry

This article examines the impact of ownership structure on the relation between firm performance and chief executive officer (CEO) turnover in the U.S. property–liability insurance industry. Theoretical implications of stock versus mutual ownership structures on the performance–turnover relation are ambiguous. Our empirical results indicate that CEO turnover is less responsive to firm underwriting performance in mutual insurers compared to stock insurers. In fact, we find that while CEO turnover for stock firms is negatively related to prior performance, no such relationship is found for mutual insurers. These results hold while controlling for board structure and other relevant factors.     

Insurance groups,product diversification,and the role of surplus lines affiliation

The market share of surplus lines insurers has grown considerably. We examine the impact of surplus lines representation within insurer groups on the extent of product diversification. Initial evidence suggests that groups with greater surplus lines representation are more diversified than other groups. These results hold when controlling for the joint impact of surplus lines representation and size, as well as surplus lines representation and the percentage of overall business written in personal lines. However, when examining the subsample of groups affiliated with surplus lines insurers, we find some evidence that supports the product focus hypothesis, which states surplus lines insurers are used to further focus on existing product lines already being written by other members of the group.     

Effizienz und Eigentümerstruktur: Eine empirische Analyse des deutschen Lebensversicherungsmarktes

We provide new insights into the effect of ownership on efficiency by analyzing the German life insurance market over the period 2002–2005. Previous research on alternative organizational forms in the life insurance industry has focused on stock and mutual ownership only. Due to the uniqueness of the German insurance market, where privately-owned companies face competition by public insurers, we add to the recent literature the well known debate on public versus private ownership, by investigating stock, mutual and public ownership forms. Using traditional DEA, we calculate technical efficiency and cost efficiency scores to test the efficient structure hypothesis as well as the expense preference hypothesis. Our results give strong support to the latter, while we find no evidence that public ownership is an efficient corporate structure for life insurers. The group of stock firms dominates both, mutual and public insurers, although differences between stock and mutual companies are smaller than differences between stock and public firms. Analyzing within-group results, our findings suggest that high efficiency scores can be associated with certain firm characteristics which are publicly available: high returns on assets, low cancellation rates and low costs.     

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.     

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.     

Organizational Structure,Board Composition,and Risk Taking in the U.S. Property Casualty Insurance Industry

This study examines the impact of organizational structure and board composition on risk taking in the U.S. property casualty insurance industry, addressing different risk‐taking behaviors from different perspectives. The risk‐taking measures include total risk, underwriting risk, investment risk, and leverage risk. The evidence shows that mutual insurers have lower total risk, underwriting risk, and investment risk than stock insurers. In terms of board composition variables, we find that some board composition variables not only have impact on risk‐taking behaviors but also affect different risk measures differently. Thus, using different risk measures is better than using one risk measure to assess risk‐taking behavior. Finally, we conclude that an insurer can control its total risk through management of underwriting, investment, and leverage risks that determine an insurer's risk profile.     

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.     

An Exploratory Analysis of Insurer Groups

Grouping is a widespread and interesting phenomenon of the insurance industry, among both life‐health insurers and property‐liability insurers. Recognizing the potentially important implications of group membership for insurer behavior and characteristics, numerous academic researchers using insurance company data have included a dummy variable in their regression analysis to control for group membership. However, it has never been clear exactly what is being controlled for when such a variable is included. This article attempts to shed light on this question. Results indicate that group affiliated insurers tend to be larger than unaffiliated insurers, are more likely to be licensed in New York, are more likely to be stock firms than mutuals, and are likely to be less geographically concentrated.     

Optimal Number of Stock Holdings in Mutual Fund Portfolios Based on Market Performance

Among the decisions that most mutual fund portfolio managers make is the number of stocks to hold. We posit that there is an optimal number of stocks for each mutual fund, reflecting the trade‐off between diversification benefits versus transactions and monitoring costs. We find a significant quadratic relation between number of stock holdings and risk‐adjusted returns for U.S. equity mutual fund portfolios during 1992–2000. Moreover, we find that changes in the number of stocks held over time are more highly correlated with mutual fund flows than with funds' investment returns.     

The effect of organizational structure on efficiency: Evidence from the Spanish insurance industry

This paper provides new information on the effects of organizational structure on efficiency by analyzing Spanish stock and mutual insurers over the period 1989–1997. We test the efficient structure hypothesis, which predicts that the market will sort organizational forms into market segments where they have comparative advantages, and the expense preference hypothesis, which predicts that mutuals will be less efficient than stocks. Technical, cost, and revenue frontiers are estimated using data envelopment analysis. The results indicate that stocks and mutuals are operating on separate production, cost, and revenue frontiers and thus represent distinct technologies. In cost and revenue efficiency, stocks of all sizes dominate mutuals in the production of stock output vectors, and smaller mutuals dominate stocks in the production of mutual output vectors. Larger mutuals are neither dominated by nor dominant over stocks in the cost and revenue comparisons. Thus, large mutuals appear to be vulnerable to competition from stock insurers in Spain. Overall, the results are consistent with the efficient structure hypothesis but are generally not consistent with the expense preference hypothesis.     

Efficiency and Demutualization: Evidence From the U.S. Life Insurance Industry in the 1980s and 1990s

This article examines the efficiency changes of U.S. life insurers before and after demutualization in the 1980s and 1990s. We use two frontier approaches (the value‐added approach and the financial intermediary approach) to measure the efficiency changes. In addition, we use Malmquist indices to investigate the efficiency and productivity change of converted life insurers over time. The results using the value‐added approach indicate that demutualized life insurers improve their efficiency before demutualization. On the other hand, the evidence using the financial intermediary approach shows the efficiency of the demutualized life insurers relative to mutual control insurers deteriorates before demutualization and improves after conversion. The difference in the results between the two approaches is due to the fact that the financial intermediary approach considers financial conditions. The results of both approaches suggest that there is no efficiency improvement after demutualization relative to stock control insurers. There is, however, efficiency improvement relative to mutual control insurers when the financial intermediary approach is used.     

On the Lack of Participating Policy Usage by Stock Insurance Companies

Stock insurers can reduce or eliminate agency conflicts between policyholders and stockholders by issuing participating insurance. Despite this benefit, most stock companies don't offer participating contracts. This study explains why. We study an equilibrium with both stock and mutual insurers in which stockholders set premiums to provide a fair expected return on their investment, and with a policyholder who chooses the insurance contract that maximizes her expected utility. We demonstrate that stockholders cannot profitably offer fully participating contracts, but can profitably offer partially participating insurance. However, when the policyholder participation fraction is high, the fair‐return premium is so large that the policyholder always prefers fully participating insurance from the mutual company. Policies with lower levels of policyholder participation are optimal for policyholders with relatively high risk aversion, though such policies are usually prohibited by insurance legislation. Thus, the reason stock insurers rarely issue participating contracts isn't because the potential benefits are small or unimportant. Rather, profitability or regulatory constraints simply prevent stock insurers from exercising those benefits in equilibrium.