Ownership Structure and Performance: The Demutualization of Life Insurers

Abstract

Introduction Diversity of organizational form is characteristic of the insurance industry. life insurance segment of the industry is dominated by mutual and stock companies. While mutual companies are far less numerous (about 5 percent of all legal reserve companies), they control almost half of the industry assets and are responsible for about 38 percent of the life insurance coverage in force. Over the last 40 years, the number of mutual life insurers has remained relatively stable, while the number of stock life companies has increased significantly.[1] In stock companies, the customer and ownership functions are distinctly separate, while these functions are merged in mutual life insurers. At least in theory, ownership rights in mutual insurers are vested in the policyholders of the company. actual degree of control exercised by policyholders has been debated (see Anderson, 1973; Greene and Johnson, 1980; Hetherington, 1969; and Kreider, 1972, for example). differences in ownership structure between mutual and stock companies naturally focus attention on the efficiency of the two organizational forms and the agency theory implications of changes in ownership structure. Previous cross-sectional empirical studies examining the performance of mutual and stock savings and loan associations (see Hadaway and Hadaway, 1981; Nicols, 1967; O'Hara, 1981; Simpson and Kohers, 1979; and Verbrugge and Goldstein 1981, for example) and mutual and stock insurers (Frech, 1980 and Spiller, 1972) concluded that stock organizations performed better than mutual organizations in terms of a set of performance measures. However, Fama and Jensen (1983), Hansmann (1985), Mayers and Smith (1981, 1986), and Smith (1986) argue for the potential efficiency of both types of organizations, theorizing a tradeoff between the costs and benefits of each form of organization. This view was summarized clearly by Smith (1986, p. 705): The different ownership structures create different incentives for the contracting parties, thus the different costs of controlling the resulting incentive problems lead to the efficiency of the various ownership structures. survival of both organizational forms has also been offered as proof of their efficiency. Fama and Jensen (1983, p. 345) note: Organizations compete for survival, and the form of organization that survives in an activity is the one that can deliver the product demanded by consumers at the lowest price while covering costs. According to Jensen and Smith (1985, p. 97), competition and survivorship produce an efficient utilization of resources. possibility of wealth transfers among various claimholders has been examined in the context of agency theory. Mayers and Smith (1986, pp. 75-76) note that stockholders of an insurer have incentives to increase the value of their stock at the policyholders' expense by making unanticipated changes in investment, financing, and dividend policies. mutual form of organization represents one way of reducing the costs of controlling incentive conflicts between stockholders and policyholders. After demutualization, however, policyholders are no longer the residual claimants of the firm, and the possibility of expropriation by stockholders increases to the extent that the policyholders' disciplining mechanisms (such as policy termination or policy loans) become less effective. Another form of incentive conflict is found between owners and managers. Because owners of mutual insurers must rely on less effective control mechanisms, managers have greater opportunities to take advantage of the policyholders. For example, more perquisite consumption and nepotism should be observed at mutual organizations than stock organizations. Hence, Smith (1986, p. 708) suggests that mutuals should have a comparative advantage in areas requiring little managerial discretion and in offering long-term contracts where renewal options are more valuable. …