Agency Theory and Life Insurer Ownership Structure

Abstract

INTRODUCTION The issue of ownership structure in the insurance industry has been the subject of extensive discussion and analysis in academic research (Mayers and Smith, 1981, 1986, 1988, 1994; Fama and Jensen, 1983a, 1983b; Hansmann, 1985; Lamm-Tennant and Starks, 1993). A primary reason for interest in this subject is the fact that the insurance industry is characterized by a number of distinct ownership structures. Life-health insurers are organized primarily as either stock companies or mutuals. Agency theory hypothesizes that certain ownership structures have advantages in engaging in particular activities due to the efficiency with which each ownership structure can control the incentive conflicts inherent in the relationships among owners, managers, and policyholders (Mayers and Smith, 1981; Fama and Jensen, 1983a, 1983b). This article uses the insights of agency theory to analyze stock versus mutual ownership structure in the life-health insurance industry. The article makes important contributions to the literature. Most significantly, this is the first study that specifically investigates the determinants of life insurer ownership structure, something which has previously been done only for property-liability insurers (Mayers and Smith, 1988, 1994; Lamm-Tennant and Starks, 1993). The magnitude of the life-health insurance industry, as well as the significant differences between it and the property-liability industry, make it important to separately investigate the issue of life insurer ownership structures.(1) In this article, we simultaneously test hypotheses regarding the owner-manager incentive conflict and the owner-policyholder incentive conflict, and control for potential effects of state regulation and taxes, age, insurer size, financial quality, and the grouping structure of insurers. Our analysis is similar to the Mayers and Smith (1994) study of ownership structure in the property-liability industry. AGENCY THEORY AND THE INSURANCE INDUSTRY The operation of the insurance industry involves three primary parties: the company owners, the company managers, and the policyholders. Agency theory as applied to insurance focuses on the incentive conflicts among these three parties and the manner in which these conflicts can be controlled. The stock ownership form is more effective at controlling the owner-manager conflict, while the mutual form is more effective at controlling the owner-policyholder conflict. The differing abilities of stocks and mutuals to efficiently control owner-policyholder and owner-manger conflicts have significant implications for the comparative advantage of the two ownership structures in various insurance activities. For example, Mayers and Smith (1981, 1988, 1994) suggest that stock firms should be more prevalent in activities that involve significant managerial discretion, since it is with these activities that potential owner-manager conflicts are most severe. By contrast, mutuals might be expected to be more prevalent in lines of business involving long-term contracting, since long-term contracts increase potential owner-policyholder conflicts (Hansmann, 1985; Mayers and Smith, 1988). Previous research has empirically examined the relationship between insurer ownership structure and activity choices in the property-liability insurance industry. Mayers and Smith (1988) provide evidence on the impact of property-liability insurer ownership structure on line-of-business activity, geographic concentration, and line-of-business specialization, while Mayers and Smith (1994) add additional controls for taxes and regulation. Lamm-Tennant and Starks (1993) find support for the hypothesis that stock insurers are associated with riskier activities. Our analysis applies agency theory to the determinants of ownership structure in the life-health insurance industry. Although certain issues related to life insurer ownership structure have been investigated, the perspective of the present analysis is different from and broader than such earlier work. …