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Journal of Business.
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Joan Lamm-Tennant
Villanova University
Laura T. Starks
University of Texas at Austin
I.
Introduction
30
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31
Mayers and Smith (1981, 1986, 1988, 1990b, 1992)and Fama and Jensen (1983a, 1983b) argue that the survival of both the corporate and
the mutualform of organizationis due in partto the relativeefficiencies
of these differentforms in controllingagency problems. With regard
to insurers,these agency problemsarise because of the threefunctions
inherentin the organizations;managerial,owner/riskbearer, and customer/policyholder.Alternate ownership structures in the insurance
industry combine these functions in different ways. Stock insurers
are characterizedby the potentially complete separationof all three
functions while mutualinsurers merge the policyholderwith the ownership function.'
Mayers and Smith (1981, 1986, 1988, 1990b, 1992)have developed
the consequences of agency conflicts between policyholdersand owners and between owners and managersfor the life insuranceindustry
and the property-liabilityinsurance industry. Under their managerial
discretion hypothesis, the difference in costs of controllingincentive
conflictsbetween owners and managersas well as between policyholders and owners influencesthe choice between the stock or mutualform
of organization.Mayers and Smith point out that the more decision
authorityagents have, the greaterthe potentialfor them to operate in
their self-interest at the expense of owners. Mutualmanagerstend to
have greaterdecision authoritythan do stock managersbecause of the
less effective marketfor corporatecontrol. Mayers and Smith predict
that the costs of controllingmanagementare significantlyhigher and
the benefits smaller for mutuals as compared to stock firms. Consequently they hypothesize that, if the cost of controllingmanagement
in mutual insurance firms is higher than in widely held stock firms,
then mutualsshouldbe more prevalentin lines of business where managementexercises little discretion. Likewise, stock insurersshould be
observed more frequently in lines where managementdiscretion is
more important.
Also employing the agency paradigm, Fama and Jensen (1983a,
1983b)discuss the separationof the risk-bearingand decision functions
in financialmutuals in general. Because of the differences in efficien1. It should also be noted that a nonparticipatingpolicyholderis similarto a debt
holder. The policyholderhas a liability claim on the insurancecompany. Thus, the
agency problemsdiscussed in the finance literaturebetween debt holders and owners
also exist between policyholdersand owners.
32
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33
34
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35
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36
37
38
TABLE 1
Journal of Business
Logistic Regression of Organization Type (Mutual = 1) on Risk and
Size for 170 Insurers
Variable
Parameter
Estimate
Standard
Error
X2
Probability
Intercept
Risk
Size
1.0917
-.0088
-.7909
.3533
.0032
.3861
9.55
7.48
4.20
.002
.006
.040
NOTE.-Riskis measuredas the varianceof a firm'stotal loss ratio,rankedacross all firmsin the
sample. Size is measuredas the percent of a firm's total premiumsearned relative to all firms'
premiumsearned. The size variable is then averagedby firm across the 8-year sample period,
1980-87. Logistic R-statistic = .174.
Panel A of table 2 contains the distributions for the total risk across
insurance companies, and panel B details the correlations between
firm total risk and other firm variables. The distributions for total risk
indicate that stock firms on average have higher variance of loss ratios
than do mutual firms. This is also evident from examining the medians.
Stock firms have a median total variance of .5%, while mutual firms
have a median total variance of .3% The difference is significant at the
.05 level. These results are consistent with our logistic regression results where we control for firm size.
The correlations in panel B indicate that there is no significant relation between the total risk of a firm and its size or the number of lines
in which it is involved, but there is a significantly positive correlation
between total risk and the number of regulatory areas or states in
which a firm is involved.8 If risk is a proxy for the amount of managerial discretion required, this result is consistent with Mayers and
Smith's (1990b) statement that the more widespread a firm's operations, the greater the managerial discretion required.
The correlations reported in panel B also indicate that larger firms
are involved in more lines of business and across more states and that
stock firms are significantly larger than mutuals. As might be expected
from these two results, stock firms have operations across more lines
of business, states, and regulatory areas.
V. Risk Analysis across Lines of Business
According to the agency theory and adverse selection arguments, mutual organizations should be involved in the less risky lines of business.
On the contrary, the efficient risk-sharing hypothesis suggests that
mutuals have a comparative advantage in offering the most risky policies. One measure of risk bearing is the concentration of premiums
8. The states can be grouped into eight areas accordingto the regulatoryprocess
withinthat area. Furtherdiscussion of this classificationis providedin Sec. VI.
39
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Journal of Business
40
41
Line
Lines with more statistically significant concentration by mutuals:
3 Farm owners multiple peril
4 Home owners multiple peril
16 Auto liability
17 Auto physical damage
Lines with more statistically significant concentration by
stocks:
7 Inland marine
10 Earthquake
14 Workers compensation
15 Other liability
19 Fidelity
20 Surety
Lines with no significant difference in concentration between
stocks and mutuals:
1 Fire
2 Allied lines
5 Commercial multiple peril
6 Ocean marine
8 Miscellaneous
9 Medical malpractice
11 Group accident and health
12 Credit accident and health
13 Other accident and health
18 Aircraft
21 Glass
22 Burglary and theft
23 Boiler and machinery
24 Credit
25 International
26 Reinsurance
Median
Two-Sample Test
(Normal Approximation)
Z
Prob > Z
Stock
Mutual
.26
6.29
15.94
12.41
1.57
13.21
27.47
20.19
4.02
4.33
3.56
2.13
.0001
.0000
.0004
.0329
2.40
.07
13.57
6.51
.13
1.01
1.43
.02
6.66
2.37
.06
.05
- 2.69
-2.93
-2.96
-3.94
-3.42
- 5.79
.0071
.0034
.0030
.0001
.0006
.0000
2.67
1.14
5.65
.48
.00
.28
.93
.59
.20
.30
.02
.06
.02
.03
.07
.99
2.89
1.19
4.60
.29
.00
.01
.79
.07
.16
.23
.01
.05
.00
.02
.09
1.06
.66
.76
- .51
- 1.20
.41
- 1.51
.43
- 1.19
-.18
-.15
.20
- 1.30
- 1.20
- 1.31
.50
- .30
.5085
.4473
.6101
.2294
.6818
.1299
.6637
.2353
.8533
.8831
.8438
.1929
.2313
.1908
.6156
.7650
flows. We first examine the concentrationof business that stocks versus mutualshave in the various states and Americanterritories.10Examiningthe averagepercentageof a firm'spremiumswrittenin a state,
10. In the interest of space, we present the summarystatisticalresults but not the
table providingdetail across the 50 states plus five Americanterritories;these statistics
are availablefrom the authors.
42
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43
Regulatory Area*
(Number of States)
Competitive areas:
1. No-rate regulation (1)
2. No-filing law (3)
3. Information filing (7)
Noncompetitive areas:
4. File and use (10)
5. Modified prior
approval (2)
6. Prior approval (24)
7. Statutory bureau (1)
8. State-made rates (2)
Stock Mutual
Median
Two-Sample Test
(Normal Approximation)
Z
More Concentrated
Organization Type
in AreaT
Prob > Z
3.55
10.23
12.41
3.59
7.47
10.38
.59
-2.29
- 1.69
.5570
.0219
.0903
...
stock
stock
10.04
10.11
1.24
.2158
...
3.39
35.56
1.24
6.93
2.12
51.17
2.34
8.18
-3.39
4.07
1.80
.89
.0007
.0000
.0717
.3748
stock
mutual
mutual
...
Journal of Business
44
selection theory of Smith and Stutzer (1990),mutualinsurancecompanies shouldbe associated with less risky futurecash flows. In contrast,
the efficientrisk-sharingtheory of Doherty and Dionne (1992)suggests
that the mutual insurer should be associated with more risky underwritingactivities. This article examines the relation between the risk
of the insurancefirm'sactivities and ownershipstructure.Ourfirsttest
is conducted on a total firmbasis, and we find that stocks have higher
total risk (measuredby the varianceof the loss ratio)than do mutuals.
Furthertests of the hypothesis are disaggregatedby line or by geographicarea and are consistent with our total firmresults. We find that
stock firmshave relatively more business in the lines of business with
the greatest total risk. Furthermore,we find that stocks sell policies
in more lines of business than do mutuals, yet the stocks are not significantlyless concentratedin more lines of business than are mutuals.
The analysis across geographicareas provides results that are consistent with the previous findings-stock firmshave greaterconcentration
in those geographicareas that have the greatest risk.
Appendix
Rate Regulatory Areas13
Competitive Areas
45
Fama,Eugene, and Jensen, Michael. 1983a.Separationof ownershipand control.Journal of Law and Economics 26:301-25.
Fama, Eugene, and Jensen, Michael. 1983b. Agency problems and residual claims.
Journal of Law and Economics 26:327-49.
Journal of Business
46
Jensen, Michael C., and Meckling, WilliamH. 1976. Theory of the firm:Managerial
behavior, agency costs and ownership structure.Journal of Financial Economics
3:305-60.
Karpoff,Jonathon,and Rice, Edward. 1989.Organizationalform, sharetransferability,
and firmperformance:Evidence from the ANCSA corporations.Journalof Financial
Economics 24:69-106.
Lo, Andrew. 1986. Logit versus discriminantanalysis:A specificationtest and application to corporate bankruptcies. Journal of Econometrics 31:151-78.
Mayers,David, and Smith, Clifford.1986.Ownershipstructureand control:Mutualization of stock life insurancecompanies.Journalof FinancialEconomics 16:73-99.
Mayers,David, and Smith, Clifford.1988.Ownershipstructureacross lines of propertycasualty insurance. Journal of Law and Economics 31:351-78.
Saunders,Anthony;Strock, Elizabeth;and Travlos, Nickolaos. 1990.Ownershipstructure, deregulation,and bank risk taking.Journalof Finance 45:643-54.
Smith,Bruce, and Stutzer,Michael. 1990.Adverse selection, aggregateuncertainty,and
the role for mutualinsurancecontracts.Journalof Business 63:493-511.
Smith, Clifford. 1986. On the convergence of insuranceand financeresearch.Journal
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