An economic analysis of demutualization in the insurance industry

The insurance industry is currently experiencing a wave of organizational structure changes as many property-liability and life-health mutual companies are converting to stock charter, a process known as demutualization. Given the long-lived coexistence of mutuals and stocks, these conversions are receiving attention from regulators, investors and consumers. This dissertation focuses on the demutualization process and investigates why certain mutuals undergo this change. The primary motivation for conversion is access to capital. By statute, mutual firms are limited in their capital-raising activities while stock firms can attract funds through a variety of stock and debt offerings. The creation of a tradable currency allows the financial market to reward efficient behavior and enhances the effectiveness of management incentive compensation plans. Demutualization may also be motivated by the potential for efficiency gains. Improvements in efficiency can be realized with a reallocation of resources, which may not be possible under the mutual organizational form. Mutual managers may recognize the potential for efficiency gains, but not expend the effort since they would not receive the commensurate compensation. Demutualization creates the proper incentives. By examining the financial characteristics of firms that demutualize, changes in business practices in the years surrounding conversion can be observed. To facilitate the appropriate comparisons, control samples of mutual insurers and stock insurers are identified. Data are obtained from annual financial statements; variables measuring performance and business focus are constructed. Determinants of the conversion decision are explored through logistic regression. Using Data Envelopment Analysis, efficiency levels are estimated. In the years before demutualization, converting property-liability mutuals have significantly lower surplus-to-asset ratios; this capital constraint eases after conversion. No other performance changes are observed. These firms experience little efficiency gain in the year after demutualization, possibly since they require time to adjust to the stock organizational form. Converting life-health mutuals hold a significantly lower proportion of liquid assets; in addition, they have a higher proportion of separate accounts under management. This liquidity constraint and increased focus on a higher managerial discretion activity drive the demutualization decision. For both property-liability and life-health converting mutuals, support for the access to capital hypothesis is found