Efficiency and demutualization: evidence from the U.S. life insurance industry in the 1980s and 1990s.

ABSTRACT

This article examines the efficiency changes of U.S. life insurers before and after demutualization in the 1980s and 1990s. We use two frontier approaches (the value-added approach and the financial intermediary approach) to measure the efficiency changes. In addition, we use Malmquist indices to investigate the efficiency and productivity change of converted life insurers over time. The results using the value-added approach indicate that demutualized life insurers improve their efficiency before demutualization. On the other hand, the evidence using the financial intermediary approach shows the efficiency of the demutualized life insurers relative to mutual control insurers deteriorates before demutualization and improves after conversion. The difference in the results between the two approaches is due to the fact that the financial intermediary approach considers financial conditions. The results of both approaches suggest that there is no efficiency improvement after demutualization relative to stock control insurers. There is, however, efficiency improvement relative to mutual control insurers when the financial intermediary approach is used.

INTRODUCTION

Which form of insurance company ownership structure--mutual or stock--is more efficient has been an important research topic in the insurance literature since the 1970s. Several earlier studies examined the performance of competing insurance ownership structures using cross-sectional analysis (e.g., Spiller, 1972; Frech, 1980). Recent studies have examined the performance of insurers that underwent the conversion (1) process from the stock form of organization to the mutual form (Mayers and Smith, 1986) and from the mutual form of organization to the stock form (McNamara and Rhee, 1992; Cole, McNamara, and Wells, 1995; Cagle, Lippert, and Moore, 1996; Mayers and Smith, 2002; Viswanathan and Cummins, 2003).

Mayers and Smith (1986) proposed the efficiency hypothesis to explain why stock life insurance companies converted to the mutual form (mutualization). This hypothesis states that insurers change their organizational structure in an effort to improve financial and operational performance given the costs and benefits inherent in each type of organizational structure. Under agency theory, the disadvantages of the mutual form are well known. Specifically, policyholders of mutual insurers exercise less effective control over managers than do shareholders at stock companies. However, mutuals eliminate the cost associated with owner-customer conflicts by unifying these interests in a single group of claimholders. The stock form of organization increases control over management and thus may improve efficiency. (2) However, stock organizations separate the customer and owner functions, which may increase contracting costs. If improved efficiency is the goal of insurer conversions, then we should observe improved operating performance after conversion.