Abstract
Organizational forms within the insurance industry include stock companies, mutuals, reciprocals, and Lloyds. We focus on the association between the choice of organizational form and the firm’s contracting costs, arguing that different organizational forms reduce contracting costs in specific dimensions. This suggests that differing costs of controlling particular incentive conflicts among the parties of the insurance firm lead to the efficiency of alternative organizational forms across lines of insurance. We analyze the incentives of individuals performing the three major functions within the insurance firm—the manager function, the owner function, and the customer function. We review evidence from the insurance industry that directly examines this product-specialization hypothesis. We then examine evidence on corporate policy choices by the alternative organizational forms: executive compensation policy, board composition, distribution system choice, reinsurance purchases, and the use of participating policies. Finally, we review evidence of the relative efficiency of the alternative organizational forms.
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Notes
- 1.
See Mayers et al. (1997).
- 2.
See Mayers and Smith (2005).
- 3.
- 4.
- 5.
- 6.
See Smith and Warner (1979).
- 7.
- 8.
See Mayers and Smith (2005).
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- 11.
Reinmuth (1967, p. 32) states, “Those reciprocals operating on a separate account basis usually provide in the subscriber’s agreement for the accumulation of a ‘contingency surplus’ by withholding a stated percentage of each subscriber’s deposit premium or ‘savings’ which will not be available on withdrawal.”
- 12.
This is really an oversimplification. The management of a reciprocal is appointed by each policyholder through the subscriber’s agreement or power of attorney. Thus, whether a subscriber has voting rights depends on the terms of the subscriber’s agreement. The job of management can in fact be proprietary. If it is, the subscriber usually has the right to vote for an advisory committee, which may or may not have the right to replace the manager. For further discussion, see Reinmuth (p. 15–16).
- 13.
As reported by Reinmuth, (p. 36): “It would appear that the subscribers of a reciprocal have the power to request a court of equity to dissolve the exchange. In McAlexander v. Waldscriber it was held that a court of equity, at the suit of a subscriber, had the power to appoint a receiver for a reciprocal insurance ‘fund,’ upon allegations that the fund was being mismanaged and dissipated by the attorney-in-fact. The receiver was directed to manage, disburse and liquidate the ‘fund’ so as to do justice to all parties in interest under their contract. In Irwin v. Missouri Valley Bridge and Iron company, a case involving a similar set of facts, the court reached a similar conclusion.”
- 14.
A good example of a case where risks were changing frequently and managerial discretion was important is marine insurance in the early nineteenth century. Wright and Fayle (1928) report the adjustment of rates by an underwriter at Lloyd’s of London. “Take, for example, the year of Trafalgar, and the routes specially affected by movements of hostile fleets. For homeward voyages from the West Indies, the average rate on 76 risk accepted by Mr. Janson during the first quarter of the year was 81∕2 per cent. The arrival of Villeneuve’s fleet in the West Indies, sent it up to 131∕2 per cent, and thence to 15 per cent and over. It touched 16 per cent when he was making for the Channel, but fell to 11 per cent after his indecisive actions with Calder and his return to Cadiz.”
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Adams (1995) analysis also suffers from this potential problem. Using canonical correlation methods, his examination of 33 New Zealand life insurance companies employing data from a single year finds little support for the managerial discretion hypothesis.
- 17.
Kleffner and Doherty (1996) suggest that ownership structure is important because of stock companies’ more ready access to capital.
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Further evidence on managerial entrenchment among mutual executives is provided by Bohn (1995). He examines CEO turnover for a sample of 93 stock and 168 mutual insurance firms from 1984 to 1992. Inconsistent with the hypothesis that mutual managers are entrenched, he finds that the unconditional probability of CEO turnover is higher in mutuals than stocks (8.3 % per annum compared to 6 %). In addition, he reports that the probability of CEO turnover is related to firm’s performance in both stocks and mutuals.
- 20.
Cole and McCullough (2006) examine overall demand for reinsurance by US insurers as well as the utilization of foreign reinsurance. Their analysis supports the prior findings. Their results suggest that the decision to utilize foreign reinsurance is driven primarily by the characteristics of the ceding company.
- 21.
Shiu’s results are limited by data problems. First, he only has indicator variables [0,1] for the use of derivatives. Second, to the extent that any of the insurers employed hybrid debt or preferred stock to hedge exposures, his data misses those instruments. Third, disclosure has varied over time; some firms report derivatives’ use only if it is material. Finally, even with more detail about the firm’s hedging activities, judging the extent of a hedge is challenging. For example, assume that company A has $10 million (notional principal) of 3-year interest rate swaps; company B has $20 million of 3-year swaps. Company A clearly hedges less than either B or C, but company B with C is more difficult. For the next 3 years, B hedges more than C, but for the succeeding 4 years, C hedges more. If we turn to options, the problems become dramatically more difficult—attempting to compare firms with contracts of different size and different exercise prices is quite difficult. In principle, one could estimate the contracts’ deltas, but deltas depend on the prices at which they are evaluated. Such problems limit the power of all empirical work in this area.
- 22.
In 1836, the Girard Life Insurance Annuity and Trust Co. Issued the first participating policy in the United States. A circular issued that year says, “The income of the company will be apportioned between the stockholders and the assured for life, an advantage given in America by this company alone.” (Stalson, 1942, p. 94).
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Mayers, D., Smith, C.W. (2013). On the Choice of Organizational Form: Theory and Evidence from the Insurance Industry. In: Dionne, G. (eds) Handbook of Insurance. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-0155-1_24
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