Presentation by Michael-Paul James on Stock Versus Mutual Ownership Structures: The Risk Implications by Joan Lamm-Tennant and Laura T. Starks.

1. Stock Versus Mutual
Ownership Structures:
The Risk Implications
Paper by Joan Lamm-Tennant and Laura T. Starks
Presentation by Michael-Paul James

2. Table of contents
Introduction Hypothesis
coexistence of mutual
and stock insurance firms
questions, context, issues
Across Lines
risk type by-line &
organization preference
Across Firms
firm-specific measures of
risk & organization type
01 02
04 05
Data & Method
data description and
approach
Geography
risk analysis across
geographic area
03
06

3. Introduction
01
questions, context, issues

4. Organizational Structures
● Functions of organizations
○ Managerial
○ Owner, Risk Bearer
○ Customer, Policyholder
● Two Organizational Structures
○ Stock insurers separate all three functions
○ Mutual insurers merge policyholder and ownership
● Endogeneity in ownership structure
○ Ownership structure affects firm decision making
○ Firm environment influences ownership structure

5. Hypothesis Conflict
● Coexistence of both forms in Property liability insurance industry
○ Mutual: less risky activities
■ Due to agency problems (Fama & Jensen, Mayers & Smith)
■ Due to adverse selection problems (Smith & Stutzer)
○ Mutual: more risky clients
■ Due to efficiency of risk sharing arrangements (Doherty &
Dionne)

6. Hypothesis
02
coexistence of mutual and stock insurance firms

7. 4 Theories to Explain Dual Form Coexistence
● Managerial Discretion Hypothesis
○ Mayers & Smith (1981, 1986, 1988, 1990, 1992)
● Employing the Agency Paradigm
○ Fama & Jensen (1983, 1983)
● Adverse Selection Problems
○ Smith and Stutzer (1990)
● Efficiency of Risk Sharing
○ Doherty and Dionne (1991, 1992)

8. Managerial Discretion Hypothesis
● Mayers & Smith (1981, 1986, 1988, 1990, 1992)
● Managerial Discretion Hypothesis: Organizational form exploits the
cost/benefit differences in incentive conflicts between policyholders
and owners and between owners and managers.
● The more decision authority, the greater potential for self-interest.
○ Mutual managers have greater authority and higher control costs
○ Mutual firms prevail when managerial discretion is less prevalent
■ Mutual insurers associated with less risky activities.
○ Stock firms prevail when management discretion is crucial.
■ Stock insurers associated with more risky activities.

9. Employing the Agency Paradigm
● Fama & Jensen (1983, 1983)
● Relative efficiencies to control agency problems leads to the choice
of stock or mutual form of organization.
● Mutuals prevail with lower costs to valuing, expanding, and contracting
assets
● Uncertain future cash flows are more often associated with stock
insurers more than mutual insurers

10. Adverse Selection Problems
● Smith and Stutzer (1990)
● Exploit adverse selection problem & aggregate non-diversifiable risk
○ Adverse selection: One party has more accurate (different)
information than the other (asymmetric information)
● Two types of insurance policies
○ Participating: Price is determined ex post (after).
■ Insured shares operating risk
■ Purchased by low risk insurance customers
■ Mutual is participating due to residual claims
○ Nonparticipating (Stock): Price is determined ex post (before).
■ Insured does not share operating risk
■ Purchased by high risk insurance customers
■ Stock is nonparticipating more often.

11. Efficiency of Risk Sharing
● Doherty and Dionne (1991, 1992)
● Focus on differences in risk sharing efficiencies between participatory
and nonparticipatory policies (focus on undiversified risk)
● When risk isn’t easily diversifiable, combining policy and equity claims
mitigates adverse selection issues.
● Mutuals assume high risk lines more efficiently than stock insurers.
● Note: This seemingly opposes the three previous theories

12. Setting up the model
● Proxy for risk that applies to both stock and mutual insurers
○ Variance of loss ratio
■ Variance of an insurer’s losses normalized for size
■ Loss ratio: Losses incurred / premiums earned
■ Correlations
● Expenses not included but correlated with profit ratio
● Correlated with uncertainty of future net cash flows (F&J)
● Correlated with business riskiness (M&S)
● Variance of losses lower for mutual (S&S)
● Risk pooling with consolidated groups correlates with
undiversified risk (D&D)

13. Contribution
● Most comprehensive study covering 95% of the US property-liability
insurance assets
● Longer 8-year data analysis than previous studies
● More comprehensive risk measures
● Analysis across firms, lines of business, and geographic areas
● Addressed competing hypothesis
● Effectively addressed agency cost, adverse selection, and efficient
risk-sharing hypotheses.

14. Data & Method
03
data description and approach

15. Data Sources and Methods
● Data Sources
○ Data on property-liability insurance companies
■ A. M. Best data tapes for 1980-87
○ Ownership Data
■ Moody's Bank and Finance Manual
■ Best's Insurance Reports
○ Vetting Criteria
■ Exclude all but stock and mutual forms
■ Only pure stock firms (not owned by mutuals)
■ Verifiable structure
■ Continuous data
○ Final Sample
■ 79 stock insurers and 91 mutual insurers

16. Across Firms
04
firm-specific measures of risk & organization type

17. Logistic Regression Equation
● Pi
= probability that the firm is in the mutual form,
● Sizei
= relative size of the firm to all sample firms
● Riski
= firm's total risk (variance of the firm's loss ratio)
● ei
= error term
● Total risk related to organizational type controlling for size
● Logistic regression model with maximum likelihood estimation
○ Independent variables not normally distributed

18. Table 1: Logistic Regression of Firm Type
● Risk is measured as the variance of a firm's total loss ratio, ranked across all sample firms
● Size is measured as the percent of a firm's total premiums earned relative to all firms'
premiums earned.
● The size variable is then averaged by firm across the 8-year sample period, 1980-87.
● Logistic R-statistic = .174.
TABLE 1
Logistic Regression of Organization Type (Mutual = 1) on Risk and Size for 170 Insurers
Variable Parameter Estimate Standard Error χ2
Probability
Intercept 1.0917 0.3533 9.55 0.002
Risk -0.0088 0.0032 7.48 0.006
Size -0.7909 0.3861 4.2 0.04

19. TABLE 2: A
Risk Analysis across Mutual and Stock Insurance Firms
A. Distribution of Variance of Insurer's Total Loss Ratio (Averaged by Firm across Years 1980-87)
Percentile Standard
N 100 75 50 25 0 Mean Deviation
Stock firms 78 62.44 1.07 0.5 0.25 0.03 1.84 7.15
Mutual firms 91 4.74 0.59 0.35 0.22 0.07 0.6 0.84
● Each variable is averaged by firm across the 8-year sample period of
1980-87.
● Median total Variance for stocks .5% and mutuals .3%

20. TABLE 2: B
Risk Analysis across Mutual and Stock Insurance Firms
B. Spearman's Correlation Coefficient across 170 Firms (Probability r > 0)
Number of
Number Number Regulatory Organization
Variance Size of States of Lines Areas Type
Variance 1.000 -0.112 0.164 0.041 0.185 -0.197
Indicates the variance of a firm's total loss ratio.
(0.000) (-0.143) (-0.032) (-0.594) (-0.016) (-0.010)
Size 1.000 0.581 0.654 0.480 -0.279
Relative size (a firm's total premiums earned/all
firms' premiums earned) x 100. (0.000) (0.000) (0.000) (0.000) (0.000)
Number of states 1.000 0.538 0.906 -0.531
Indicates the number of states in which a firm
has premiums earned. (0.000) (0.000) (0.000) (0.000)
Number of lines 1.000 0.496 -0.251
Indicates the number of lines in which a firm has
premiums earned. (0.000) (0.000) (0.000)
Number of regulatory areas 1.000 -0.477
Indicates the number of state regulatory areas in
which a firm has premiums earned. (0.000) (0.000)
Organization type 1.000
This is a dummy variable that is zero for stock
firms and one for mutual firms. (0.000)

21. Across Lines
05
risk type by-line & organization preference

22. TABLE 3: A
Concentration in Lines of Business by Mutual and Stock Insurers Averaged across Years 1980-1987: Analysis of Which Organization Type
Has a Greater Proportion of Premiums Concentrated in a Particular Line of Business
Median% of
Firm's Premiums in Line*
Median Two-Sample Test
(Normal Approximation)
Line Stock Mutual Z Prob> Z
Lines with more statistically significant concentration by mutuals:
3 Farm owners multiple peril 0.26 1.57 4.02 0.0001
4 Homeowners multiple peril 6.29 13.21 4.33 0.000
16 Auto liability 15.94 27.47 3.56 0.0004
17 Auto physical damage 12.41 20.19 2.13 0.0329
Lines with more statistically significant concentration by stocks:
7 Inland marine 2.4 1.43 -2.69 0.0071
10 Earthquake 0.07 0.02 -2.93 0.0034
14 Workers compensation 13.57 6.66 -2.96 0.003
15 Other liability 6.51 2.37 -3.94 0.0001
19 Fidelity 0.13 0.06 -3.42 0.0006
20 Surety 1.01 0.05 -5.79 0.000
Median
SD
.047
Median
SD
.106

23. TABLE 3: B
Concentration in Lines of Business by Mutual and Stock Insurers Averaged across Years 1980-1987: Analysis of Which Organization Type
Has a Greater Proportion of Premiums Concentrated in a Particular Line of Business
Median% of
Firm's Premiums in Line*
Median Two-Sample Test
(Normal Approximation)
Line Stock Mutual Z Prob> Z
Lines with no significant difference in concentration between stocks and mutuals:
1 Fire 2.67 2.89 0.66 0.5085
2 Allied lines 1.14 1.19 0.76 0.4473
5 Commercial multiple peril 5.65 4.6 -0.51 0.6101
6 Ocean marine 0.48 0.29 -1.2 0.2294
8 Miscellaneous 0 0 0.41 0.6818
9 Medical malpractice 0.28 0.01 -1.51 0.1299
11 Group accident and health 0.93 0.79 0.43 0.6637
12 Credit accident and health 0.59 0.07 -1.19 0.2353
13 Other accident and health 0.2 0.16 -0.18 0.8533
18 Aircraft 0.3 0.23 -0.15 0.8831
21 Glass 0.02 0.01 0.2 0.8438
22 Burglary and theft 0.06 0.05 -1.3 0.1929
23 Boiler and machinery 0.02 0 -1.2 0.2313
24 Credit 0.03 0.02 -1.31 0.1908
25 International 0.07 0.09 0.5 0.6156
26 Reinsurance 0.99 1.06 -0.3 0.765

24. Geography
06
risk analysis across geographic area

25. Rate Regulatory Areas
● 2 groups, 8 classes of regulatory laws (Witt and Miller 1983)
● Competitive Areas
○ No-rate regulatory law: 1 State
■ Rates unregulated but subject to state antitrust laws, no rate
collaboration, monitored by advisory boards.
○ No-filing law: 3 States
■ No filing nor rate approval requirements with authorities.
Rating bureau advisory. Monitor on ex post basis.
○ Information-filing law: 7 States
■ Filing requirement but rate approval not required. Rating
bureau advisory. Monitor on ex post basis.

26. Rate Regulatory Areas
● Noncompetitive Areas
○ File and use law: 10 States
■ Rates filed and approved by regulatory authorities.
○ Modified prior approval law: 2 States
■ Rates filed & approved prior to implementation (exceptions)
○ Prior approval law: 24 States
■ Rates filed & approved prior to implementation (no exceptions)
○ Statutory bureau law: 1 state
■ Compulsory Insurer membership in designated rating bureau
○ State-made rates: 2 states
■ Rates are set by a state agency, deviations allowed

27. TABLE 4
Concentration in State Regulatory Areas by Mutual and Stock Insurers Averaged across Years 1980-87
Analysis of Which Organization Type Has More Premiums Concentrated in a Particular Regulatory Area
Median % of Firm's
Premiums in State
Median Two-Sample Test
(Normal Approximation)
More Concentrated
Organization Type in
Area*
(Number of States) Stock Mutual z Prob> Z
Competitive areas:
1. No-rate regulation (1) 3.55 3.59 0.59 0.557 ...
2. No-filing law (3) 10.23 7.47 -2.29 0.0219 stock
3. Information filing (7) 12.41 10.38 -1.69 0.0903 stock
Noncompetitive areas:
4. File and use (10) 10.04 10.11 1.24 0.2158 ...
5. Modified prior approval (2) 3.39 2.12 -3.39 0.0007 stock
6. Prior approval (24) 35.56 51.17 4.07 0 mutual
7. Statutory bureau (1) 1.24 2.34 1.8 0.0717 mutual
8. State-made rates (2) 6.93 8.18 0.89 0.3748 ...
● Rate regulatory areas are defined in the App.
● Indicates the median across firms of the percent of the firm's regulatory area. The total premiums earned in an area were averages 1980-87
● Indicates the organization type with the higher significant concentration of business in a state regulatory area

28. Summary
● 4 Hypothesis concerning the coexistence of stock and mutuals
○ Mutuals assume less risk
■ Agency theory and adverse selection
○ Mutuals assume more risk
■ Efficient risk sharing theory
● Findings
○ On average, stock firms have higher total risk than mutuals,
measured by variance to loss ratios
■ Consistent results across firm, (risky) business lines, and (risky)
geography

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