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An analysis of post-demutualisation in the property–liability insurance industry

Abstract

Using a quasi-natural experiment, we examine how demutualisation affects demutualised insurers’ capital, organisational flexibility and alignment of managerial incentives post-demutualisation. First, our results show demutualised insurers have faster surplus growth than matching insurers post-demutualisation. However, the surplus growth differs between demutualised insurers with and without surplus notes. Specifically, the evidence shows that demutualised insurers with surplus notes experience long-term surplus growth, while demutualised insurers without surplus notes experience short-term surplus increases. Second, we find that increased organisational flexibility facilitates merger and acquisition activities for demutualised insurers and helps them to pursue growth and diversification. We find that 51% of demutualised stock insurers become targets in the conversion year. Finally, we find that demutualised insurers have lower underwriting expenses and underwrite more in commercial lines post-demutualisation. Overall, our evidence shows that demutualisation has a positive impact on surplus growth, organisational flexibility and the alignment between managerial incentives and owners' interests.

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Notes

  1. Please note that the 157 demutualisations include reciprocals; 1920–1988: 98 cases (Mayers and Smith 2002); 1989–1990: 1 case (Best’s Insurance Report); 1991–1999: 34 cases (Viswanathan and Cummins 2003); 1997–2009: 45 cases in our sample.

  2. Except for investor surplus notes which are usually issued by financially strong insurers. There is only one insurer issuing investor surplus notes in our sample.

  3. Issuing surplus notes is the only way to raise equity capital externally for mutual insurers and the amount cannot exceed 15% of the insurer’s surplus (Belth 1996).

  4. Blockholders in the finance literature are generally defined as stockholders who hold more than 5% of the stock of a company.

  5. Since 2008, there have been some other demutualisation cases. For example, Federal Life Mutual Holding Company demutualised in December 2018. Economical insurance, a P–L insurer in Canada, is under the demutualisation process now and Dai-ichi Mutual Life Insurance Co., the second-largest life insurer in Japan, demutualised on 1 April 2010. Demutualisation does not occur only in the insurance industry but also in other financial industries (e.g. Mastercard, Visa, etc.) and stock exchanges (e.g. New York Stock Exchange).

  6. We focus on the prior two methods since we only observe these two in our sample.

  7. Some transactions are paid by a mixture of stocks and cash.

  8. It should be noted that we use cross-sectional regressions rather than panel data regressions.

  9. SNL Financial data has now joined forces with S&P Capital IQ to form S&P Global Market Intelligence.

  10. We start in 1996 because no electronic database is available before 1996. It would be very difficult to find matching firms without an electronic database.

  11. The sample includes reciprocals since they are now not distinguishable from mutuals (Cummins and Weiss 1993).

  12. The reason we match at t = − 1 is that treatment insurers (demutualised insurers) and non-treatment insurers (the matching mutuals) should have similar characteristics right before demutualisation.

  13. This study uses mutual insurers as matching insurers. One may suggest that we should use stock insurers. We believe that using stock insurers as matching firms may not be appropriate because we want to examine the differences with and without the benefits of demutualisation.

  14. We excluded eight demutualised insurers while doing the univariate and multivariate analyses due to missing data on the matching criteria.

  15. Two demutualised insurers drop out of the sample since year 3 and another one since year 4. We also use the sample of 28 demutualised insurers and the matching mutuals with five-year complete data and the results are similar. We do the same for both univariate and multivariate analyses.

  16. The dependent variables are cumulative. Surplus change (ΔSurplus− 1,t) is defined as Surplust/Surplus− 1–1, where t stands for years 1, 2, 3, 4 and 5. For example, ΔSurplus− 1,5 is defined as changes in surplus from t = − 1 to t = 5. Specifically, ΔSurplus− 1,5 = Surplus5/Surplus− 1–1. For each time period, we run a regression with the dependent variable ΔSurplus− 1,t. We run five regressions in total.

  17. It is observed that the demutualised insurers drop a large number of lines in year 5. The result is driven by one demutualised insurer, Milwaukee Insurance Company, who dropped 15 lines in year 5. It could be a strategic change in the line of business since it merges with another insurer and adds new lines in year 4.

  18. 10.35 is the sample average standard deviation of loss ratio for year 3.

  19. To address the concern about the PSM method, we conduct regression analyses with control variables. Pan and Bai (2015) review PSM and state that “propensity score matching plus regression with controlling for covariates in the outcome analysis will produce robust estimates of treatment effects regardless of the choice of propensity score matching methods.” Note that we try to include all important control variables. If we omit important variables, then PSM does not guarantee the correct result.

  20. The results are available upon request.

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Correspondence to Gene Lai.

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Appendices

Appendix 1: Demutualised insurers in the property–liability insurance industry

Property–liability mutual Demutualisation year Inc. state
Goschenhoppen-Home Mutual Insurance Co 1997 PA
Old Guard Mutual Fire Insurance Co 1997 PA
Old Guard Mutual Insurance Co 1997 PA
Patrons Oxford Mutual Insurance Co 1997 ME
Select Risk Mutual Insurance Co 1997 PA
Allegheny Mutual Casualty Co 1998 PA
Compensation Mutual Insurance Company 1998 ME
FCCI Mutual Insurance Co 1998 FL
Pioneer Mutual Insurance Co. (NY) 1998 NY
Farmers Casualty Company Mutual 1999 IA
Lakeland Mutual Insurance Company 1999 PA
Medical Inter-Insurance Exchange of New Jersey 1999 NJ
Michigan Educational Employees Mutual Insurance Co 1999 MI
Pennsylvania Millers Mutual Insurance Co 1999 PA
The Millers Mutual Fire Insurance Co 1999 TX
FCCI Commercial Insurance Fund 2000 FL
Millers Mutual Insurance Company 2000 PA
Mutual Insurance Corporation of America 2000 MI
Florida Family Mutual Insurance Company 2001 FL
Attorneys Liability Protection Society, A Mutual RRG 2001 MT
Michigan Lawyers Mutual Insurance Company 2001 MI
First Commercial Mutual Company 2002 FL
First Nonprofit Mutual Insurance Company 2002 IL
Garrison Property and Casualty Association 2003 TX
Mercer Mutual Insurance Company 2003 PA
Millers Mutual Insurance Company 2003 IL
Milwaukee Mutual Insurance Company 2003 WI
Fremont Mutual Insurance Company 2004 MI
Le Mars Mutual Insurance Company of Iowa 2004 IA
Employers Insurance Company of Nevada, A Mutual Company 2005 NV
Petroleum Marketers Mutual Insurance Company 2005 IA
Farmers Home Mutual Fire Insurance Company 2006 AR
Louisiana United Businesses Self Insurers Fund 2006 LA
Mutual Service Casualty Insurance Company 2006 MN
American Physicians Insurance Exchange 2007 TX
IMT Insurance Company (Mutual) 2007 IA
Patriot Mutual Insurance Company 2007 ME
Sheboygan Falls Mutual Insurance Company 2008 WI
Commercial Mutual Insurance Company 2009 NY

Appendix 2: Variable definitions

Variable Definition
I(Dem) A dummy variable equal to 1 for demutualised insurers and 0 otherwise
I(DemSN) A dummy variable equal to 1 for demutualised insurers with surplus notes in year − 1 and 0 otherwise
I(DemwoSN) A dummy variable equal to 1 for demutualised insurers without surplus notes in year − 1 and 0 otherwise
I(DemSNACQ) A dummy variable equal to 1 for demutualised insurers with surplus notes in year − 1 that are taken over post-demutualisation and 0 otherwise
I(DemSNwoACQ) A dummy variable equal to 1 for demutualised insurers with surplus notes in year − 1 that are not taken over post-demutualisation and 0 otherwise
Size The natural logarithm of net total assets in 1999 dollar value
Surplus/Assets Surplus to net total assets ratio
Reinsurance ratio Reinsurance ceded/(direct premiums written + reinsurance assumed)
% commercial lines premiums Percentage of net premiums written in commercial lines
Line of business Herfindahl Herfindahl index calculated based on net premiums written on each line, i.e. the sum of the square of net premiums written on each line divided by the square of the insurer’s net premiums written
ROA Return on assets defined as net income to net total assets
Loss ratio (Loss incurred + loss adjustment expenses)/net premiums earned
Risk The standard deviation of the loss ratio
totRisk Total risk is measured by the standard deviation of return on assets. Return on assets is defined as net income to net total assets
invRisk Investment risk is measured by the standard deviation of return on investments, where the return on investments is defined as net investment gain or loss to investment assets
Tax rate Federal income tax/taxable income
Expense ratio Underwriting expense/premiums written
ΔSurplus Surplust/Surplus− 1–1, where t stands for 1, 2, 3, 4 and 5 years post-demutualisation and surplus is in 1999 dollar value
ΔDPW DPWt/DPW− 1–1, where t stands for 1, 2, 3, 4 and 5 years post-demutualisation and DPW stands for direct premiums written in 1999 dollar value
ΔReins Reinst-Reins− 1, where t stands for 1, 2, 3, 4 and 5 years post-demutualisation and Reins stands for reinsurance ratio defined as reinsurance ceded to direct premiums written and reinsurance assumed
Ave. tax rate The average tax rate from year − 1 to t, where the tax rate is defined as federal income tax to taxable income
Ave. ROA The average ROA from year − 1 to t, where ROA is defined as net income to net total assets
ΔNPW NPWt/NPW− 1–1, where t stands for 1, 2, 3, 4 and 5 years post-demutualisation and NPW is in 1999 dollar value
ΔComm Commt-Comm− 1, where t stands for 1, 2, 3, 4 and 5 years post-demutualisation and Comm is the percentage of NPW in commercial lines
ΔExpense Expenset-Expense− 1, where t stands for 1, 2, 3, 4 and 5 years post-demutualisation and Expense is the expense ratio defined as underwriting expense to premiums written
Group A dummy variable equal to 1 if the insurer belongs to an insurance group and 0 otherwise
Operating ratio The combined ratio minus the investment income ratio
Agent balance-to-DPW ratio Agents’ balances/DPW
Ave. no. lines The average number of lines that the insurer underwrites from year − 1 to t
Ave. admin exp The average administrative expense ratio from year − 1 to t, where administrative expense ratio is defined as the administration and other expenses to NPW

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Jin, L., Lai, G. & Ho, CL. An analysis of post-demutualisation in the property–liability insurance industry. Geneva Pap Risk Insur Issues Pract 47, 279–320 (2022). https://doi.org/10.1057/s41288-021-00231-9

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Keywords

  • Demutualisation
  • Access to capital
  • Organisational flexibility
  • Managerial incentive alignment