The Relations among Organizational and Distribution Forms and Capital and Asset Risk Structures in the Life Insurance Industry

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This article is the first step toward integrating in a single framework two previously separate lines of research on major structural decisions of life insurers. The literature has previously studied the relation between capital structure and asset risk on the one hand, and the relation between organizational form and distribution system on the other hand, without integrating them. Using life insurer data for 1993-1999, we model the four key insurer decisions of capital structure, asset risk, organizational form, and distribution system as endogenous choices in a single interrelated set of simultaneous equations. The model assesses the nature of the interactions among these decisions. The model also assesses the impact of insurers" fundamental business strategy (treated as predetermined) on these choices. The business--strategy hypothesis views other key decisions as jointly determined and driven by the fundamental business strategy, once the latter is set in motion. Confirming previous studies, we find a positive relation between capital ratios and asset risk. We also find an association in the simultaneous context between stock ownership and brokerage distribution, which was not found in prior studies. Stock ownership is related to greater financial and asset risk taking, whereas brokerage distribution is associated with lower risk taking. These and other results are interpreted in light of several theories, including transaction-cost economics (TCE), agency theory, and regulatory and bankruptcy cost avoidance. Deriving from these theories, the finite risk paradigm emerges as the most comprehensive interpretation of the results, as opposed to the risk-subsidy hypothesis of the impact of guarantee funds. We also find support for the notion that the business strategy drives the capital and distribution decisions, as predicted by TCE.



This article is the first step toward integrating two separate strands of research. The relation between capital structure and asset risk has been examined previously in a simultaneous framework (Cummins and Sommer, 1996; Baranoff and Sager, 2002). Similarly, the relation between organizational form and distribution system has received attention (Regan and Tzeng, 1999). (1) But the four factors of capital structure, asset risk, organizational form, and distribution system have not previously been analyzed as a single integrated set of simultaneously determined decisions. It has also been proposed that the firm's selection of a business product logically precedes and strongly influences some of these factors (Regan and Tzeng, 1999; Williamson, 1985, 1988). In this study we undertake an analysis of the life insurance industry for the period 1993-1999 using a model that treats the major structural decisions as an interrelated process once the product has been determined. We use the phrase business-strategy hypothesis for the idea that the product decision underlies and affects the four strategic decisions mentioned above.

This study is an empirical expedition. To be sure, we interpret our results in light of various applicable theories. But we do not attempt to validate any theory. The theories used for this purpose include transaction-cost economics (TCE), agency theory, and bankruptcy and regulatory costs hypotheses, which underlie the finite risk paradigm. The idea that firms limit total risk lies at the heart of the finite risk framework. Both TCE and agency theory provide a foundation for finite risk: TCE through its core idea that firms exist to minimize transactional costs, and agency theory through its idea that owners, managers, and customers monitor each other's behaviors. We find that finite risk provides the most comprehensive framework for our results. An opposing theory is the risk-subsidy hypothesis, which maintains that the operation of guarantee funds provides consumer safeguards. These safeguards reduce incentive to limit risk taking, especially by marginally solvent insurers. …


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