Efficiency in the international insurance industry: A cross-country comparison

The purpose of this paper is to provide new empirical evidence on frontier efficiency measurement in the international insurance industry, a topic of great interest in the academic literature during the last several years. A broad efficiency comparison of 6462 insurers from 36 countries is conducted. Different methodologies, countries, organizational forms, and company sizes are compared, considering life and non-life insurers. We find a steady technical and cost efficiency growth in international insurance markets from 2002 to 2006, with large differences across countries. Denmark and Japan have the highest average efficiency, whereas the Philippines is the least efficient. Regarding organizational form, the results are not consistent with the expense preference hypothesis, which claims that mutuals should be less efficient than stocks due to higher agency costs. Only minor variations are found when comparing different frontier efficiency methodologies (data envelopment analysis, stochastic frontier analysis).     

Regulator performance,regulatory environment and outcomes: An examination of insurance regulator career incentives on state insurance markets

In this paper we test whether the past or future labor market choices of insurance commissioners provide incentives for regulators in states with price regulation to either favor or oppose the industry by allowing prices that differ significantly from what would otherwise be the competitive market outcome. Using biographical data on insurance regulators, economic and state specific market structure and regulatory variables, and state premium and loss data on the personal automobile insurance market, we find no evidence consumers in prior approval states paid significantly different “unit prices” for insurance than consumers in states that allow competitive market forces to determine equilibrium prices during the time period 1985–2002. We do, however, find evidence regulators who obtained the position of insurance commissioner by popular election and those who seek higher elective office following their tenure as insurance commissioner allow higher overall “unit prices” relative to competitive market states. The “unit price” of insurance in regulated states is not statistically different from the competitive market outcome for regulators that make lateral moves back into state government and it is mildly higher for regulators who enter the insurance industry following their tenure. Finally, we find some evidence regulators who describe themselves as consumer advocates are successful reducing the price of insurance in favor of consumers in regulated markets. Overall the results are consistent with the existence of asymmetric information in the regulatory process that agents use to enhance their career aspirations.     

Variable annuities and the option to seek risk: Why should you diversify?

We analyze the impacts of an additional rider incorporated in recent retirement products. The payoff is linked to the performance of a multi asset investment strategy and includes a minimum interest rate guarantee. In addition, the buyer receives the option to decide on the investments dynamically. Prominent examples are so called variable annuities. Due to the embedded guarantee, these products are interesting for risk averse investors who benefit from diversification. However, the price setting of the provider takes into account the most risky strategy. This implies that the investor mitigates optimally between the diversification and the worst case strategy. We analyze the distortion and utility effects caused by the additional rider in the presence of background risk and borrowing constraints. A simulation analysis sheds light on the question if the additional rider is worth its costs.     

Momentum or contrarian investment strategies: Evidence from Dutch institutional investors

This paper analyses investment strategies of three types of Dutch institutional investors - pension funds, life insurers and non-life insurers - over the period 1999-2005. We use balance sheet and cash flow data, including purchases and sales of equity, fixed income and real estate. We trace asset reallocations back to both active trading and revaluations and link investment decisions to firm-specific characteristics and macroeconomic variables. Overall, our results indicate that all three investor types tend to be contrarian traders, i.e. they buy past losers and sell past winners. Especially pension funds showed this behaviour in the most turbulent part of the sample - the crash of 2002 and early 2003 - implying that these institutions have a stabilising impact on financial markets when this is needed most. Life insurers tend to be contrarian traders when they have a high proportion of unit-linked policies, while non-life insurers are contrarian when they have a more risky business model.     

Optimal pension insurance design

In this paper we analyze how the traditional life and pension contracts with a guaranteed rate of return can be optimized to increase customers’ welfare. Given that the contracts have to be priced correctly, we use individuals’ preferences to find the preferred design. Assuming CRRA utility, we cannot explain the existence of any form of guarantees. Through numerical solutions we quantify the difference (measured in certainty equivalents) to the preferred Merton solution of direct investments in a fixed proportion of risky and risk free assets. The largest welfare loss seems to come from the fact that guarantees are effective by the end of each year, not only by the expiry of the contract. However, the demand for products with guarantees may be explained through behavioral models. We use cumulative prospect theory as an example, showing that the optimal design is a simple contract with a life-time guarantee and no default option.     

Equity home bias and corporate disclosure

I show that more comprehensive corporate disclosure reduces investors’ uncertainty about domestic companies’ payoffs at no cost, thereby decreasing investors’ equity home bias toward a country. Since investors should base their investment decisions on valid and easily interpretable company information only, more comprehensive disclosure will reduce the home bias only if domestic securities law is sufficiently stratified and domestic companies use international accounting standards. Using panel data for 38 countries from 2003 to 2008 I find that more comprehensive disclosure reduces investors’ home bias, though significantly only for countries that sufficiently enforce their securities law and implement international accounting standards.     

The components of the illiquidity premium: An empirical analysis of US stocks 1927–2010

This paper implements a conditional version of the liquidity adjusted CAPM (LCAPM). The conditional LCAPM allows for a time-varying decomposition of the total illiquidity premium into a level component and three risk components. The estimated average annual total illiquidity premium for US stocks 1927–2010 is 1.74–2.08%, which is substantially lower than in most previous studies. The contributions from illiquidity level and illiquidity risk are 1.25–1.28% and 0.46–0.83%, respectively. Of the three illiquidity risk components, risk related to the hedging of wealth shocks is the most important, while commonality risk is the least important. The illiquidity premia are clearly time-varying, with peaks in downturns and crises, but with no general tendency to decrease over time. The level premium and the risk premium are significantly positively correlated, at around 0.35; indicating that in periods of turbulence both illiquidity cost and illiquidity risk premia tend to be high.     

An analysis of commodity markets: What gain for investors?

In this paper we study whether the commodity futures market predicts the commodity spot market. Using historical daily data on four commodities—oil, gold, platinum, and silver—we find that they do. We then show how investors can use this information on the futures market to devise trading strategies and make profits. In particular, dynamic trading strategies based on a mean–variance investor framework produce somewhat different results compared with those based on technical trading rules. Dynamic trading strategies suggest that all commodities are profitable and profits are dependent on structural breaks. The most recent global financial crisis marked a period in which commodity profits were the weakest.     

Do jumps contribute to the dynamics of the equity premium?

This paper investigates whether risks associated with time-varying arrival of jumps and their effect on the dynamics of higher moments of returns are priced in the conditional mean of daily market excess returns. We find that jumps and jump dynamics are significantly related to the market equity premium. The results from our time-series approach reinforce the importance of the skewness premium found in cross-sectional studies using lower-frequency data; and offer a potential resolution to sometimes conflicting results on the intertemporal risk-return relationship. We use a general utility specification, consistent with our pricing kernel, to evaluate the relative value of alternative risk premium models in an out-of-sample portfolio performance application.     

Competition among mutual funds

We examine the impact of the entry of new mutual funds on incumbents using the overlap in their portfolio holdings as a measure of competitive intensity. This simple metric delivers powerful economic results. Incumbents that have a high overlap with entrants subsequently engage in price competition by reducing management fees. Distribution fees, however, rise so that investors do not benefit as much from price competition. Funds with high overlap also experience quantity competition through lower investor flows, have lower alphas, and higher attrition rates. These effects only appear after the late 1990s, at which point there appears to be an endogenous structural shift in the competitive environment. We conclude that the mutual fund market has evolved into one that displays the hallmark features of a competitive market.     

Asset restructuring strategies in bank acquisitions: Does distance between dealing partners matter?

One of the most lively-debated effects of banking acquisitions is the change in lending and asset allocation of the target bank in favour of transaction-based products, at the expense of small and informationally opaque borrowers. These changes may be the result of two distinct restructuring strategies pursued by the acquirer with respect to the asset portfolio of the acquired bank: a cleaning strategy (CS), in which the acquirer makes a clean sweep of all the negative net present value activities in the portfolio of the acquired bank, and a portfolio strategy (PS), in which the acquiring bank permanently changes the portfolio allocation of the acquired bank. In this paper we focus on Italian bank acquisitions and test which asset restructuring strategy was predominantly pursued over the period 1997–2003. Moreover, we distinguish acquisitions according to their geographic diversifying character and to the physical and cultural distances that separate acquiring from acquired banks. When we look at the mean value, we do not find clear evidence of a primacy either of CSs or PSs. When we separate in-market from out-of-market bank acquisitions, however, results show that the CSs prevail only in the former type of deals, while in the latter the portfolio of acquired banks is subject to PSs. Finally, we find that differences in asset restructuring strategies can be explained by differences in corporate culture and the workplace environment of the dealing partners.     

Convertible security design and contract innovation

This paper studies convertible security design for a sample of 814 issuers over the years 2000 through 2007. Using a nested logit model, we examine how firms choose fixed income claims and the method of payment. We find that fixed income claims are chosen to reduce corporate income taxes, minimize refinancing costs, and help mitigate managerial discretion costs. The method of payment choice frequently includes cash settlement features because they increase reported diluted earnings per share. Some of the cash settlement issuers also adopt other innovative financial strategies (share repurchase programs and call spread overlays) that inflate reported earnings per share. We find that firms needing debt capacity include mandatory conversion features.     

The determinants of corporate board size and composition: An empirical analysis

Using a unique panel dataset that tracks corporate board development from a firm's IPO through 10 years later, we find that: (i) board size and independence increase as firms grow and diversify over time; (ii) board size—but not board independence—reflects a tradeoff between the firm-specific benefits and costs of monitoring; and (iii) board independence is negatively related to the manager's influence and positively related to constraints on that influence. These results indicate that economic considerations—in particular, the specific nature of the firm's competitive environment and managerial team—help explain cross-sectional variation in corporate board size and composition. Nonetheless, much of the variation in board structures remains unexplained, suggesting that idiosyncratic factors affect many individual boards’ characteristics.     

Are mutual fund fees excessive?

There is a long running debate over whether competition in the mutual fund industry limits the ability of investment advisors to charge fees that are disproportionate to the services they provide. We posit that disproportionately high fees are prevalent in funds with multiple share classes and those with weak governance structures. Using a comprehensive sample of index mutual funds for the from 1998 to 2007, we find that internal governance mechanisms matter primarily for funds with relatively small share classes where investors often face increased search costs and/or restricted access to competitive mutual funds. Additionally, we find that funds managed by publicly held sponsors are associated with disproportionately higher fee spreads (about 28 basis points). The results are robust to the inclusion of board characteristics, share class structure, and investment objectives. Overall, our findings suggest that competition and agency considerations are important determinants in the pricing of mutual funds.     

Institutional demand pressure and the cost of corporate loans

Between 2001 and 2007, annual institutional funding in highly leveraged loans went up from $32 billion to $426 billion, accounting for nearly 70% of the jump in total syndicated loan issuance over the same period. Did the inflow of institutional funding in the syndicated loan market lead to mispricing of credit? To understand this relation, we look at the institutional demand pressure defined as the number of days a loan remains in syndication. Using market-level and cross-sectional variation in time-on-the-market, we find that a shorter syndication period is associated with a lower final interest rate. The relation is robust to the use of institutional fund flow as an instrument. Furthermore, we find significant price differences between institutional investors’ tranches and banks’ tranches of the same loans, even though they share the same underlying fundamentals. Increasing demand pressure causes the interest rate on institutional tranches to fall below the interest rate on bank tranches. Overall, a one-standard-deviation reduction in average time-on-the-market decreases the interest rate for institutional loans by over 30 basis points per annum. While this effect is significantly larger for loan tranches bought by collateralized debt obligations (CDOs), it is not fully explained by their role.