Form over Matter: Differences in the Incentives to Convert Using Full versus Partial Demutualization in the U.S. Life Insurance Industry

Article excerpt


We explore the recent wave of demutualizations in the U.S. life insurance industry and analyze if the motives were similar for mutual life insurers that fully demutualized versus those that converted to mutual holding company (MHC) form. We find that fully demutualizing insurers were primarily motivated by a desire to gain access to external capital markets while those that chose MHC were motivated by other incentives including a tax-based incentive. We also document that after conversion, fully demutualizing insurers more aggressively increase their exposure to risks they have a comparative advantage to bear than do firms that convert to MHC.


Recent experience suggests the mutual form of ownership in the U.S. life insurance industry is in doubt. Consider, in 1986, insurers organized in the mutual form of ownership, where the insurers' policyholders were also residual claimants, held 49 percent of total industry assets. By 2006, this percentage dropped to less than 10 percent with the stock form ownership now dominating the industry (1) (A.M. Best, 2007). The majority of the change can be explained by the wave of demutualizations that occurred during the 1990s and into the 21st century as a number of large and historically successful life insurers became attracted by the relative advantages of being organized as a stock company.

Given the dramatic change in industry structure, a number of papers have investigated the motivations behind demutualizations in the life insurance industry. However, there exists an interesting aspect of the demutualization story that has, until now, garnered little attention in the academic literature. In all of the previous empirical work, researchers have only considered the decision of whether an insurer converted from the mutual to the stock form of ownership. In reality, however, not only did the managers of a mutual life insurance company have to decide whether to demutualize, they also had to choose from different types of demutualization, including a full (or traditional) demutualization (2) and a mutual holding company (MHC) conversion. (3)

This article adds to the literature in at least four important ways. First, we improve on the existing literature by considering the method of conversion in an effort to gain additional insight into what motivated insurers to demutualize generally and then to explore if the motivations were similar across the firms that chose to fully demutualize versus those that chose to adopt the MHC form.

A second way that we improve upon the previous literature is by hypothesizing that the federal tax code provided mutual insurers an incentive to demutualize after Congress passed Internal Revenue Code (IRC) Section 809 in 1984. This section was a compromise in the Deficit Reduction Act (DEFRA) of 1984 that sought to create a level playing field between the stock and mutual segments of the industry by limiting the mutual companies' dividend deduction against pretax income. The reduction in the deduction was equal to the difference in average earnings between stocks and mutuals multiplied by the equity base of the mutual company. (4) Thus, mutual companies with larger equity bases are hypothesized to have had greater incentives to demutualize. To our knowledge, this tax hypothesis has not previously been tested.

Our third contribution to the literature on life insurer demutualizations is our analysis of the risk taking incentives of converting firms both before and after their conversion to the stock organizational form. Drawing on the coordinated risk management hypothesis of Stulz (1996) and Schrand and Unal (1998), we argue that the managers of demutualizing insurers have a stronger incentive to maximize firm value. Therefore, they will increase exposure to risks more likely to generate positive economic rents and will minimize, or at least not increase, exposure to risks expected to generate zero economic rents. …


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