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.

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