Academic journal article Journal of Risk and Insurance

Property-Liability Insurance Company Market Pullout Announcements and Shareholder Wealth

Academic journal article Journal of Risk and Insurance

Property-Liability Insurance Company Market Pullout Announcements and Shareholder Wealth

Article excerpt

ABSTRACT

This study presents an analysis of the wealth effects of property-liability insurance company market pullout announcements on the shareholders of both the withdrawing firms and their major competitors. The results of the study indicate that market withdrawals are positively interpreted by financial market participants, as the share prices of the withdrawing companies experience statistically significant risk-adjusted mean price increases of about one percent. On average, there is little evidence that market withdrawals adversely affect major competitors of the withdrawing insurance companies.

INTRODUCTION

The primary tenet of both financial and insurance economics is that individuals and organizations behave in manners consistent with their own perceived best interests. Indeed, the principle of self-interest underlies a host of extraordinarily complex issues, ranging from agency and stakeholder conflicts to contract law. For example, the oft-discussed problems associated with adverse selection in insurance markets (see, e.g., Berger and Cummins, 1992) result from efforts to exploit the incongruities between the opposing self-interests of insurance companies and potential policy owners. Signaling theory, on the other hand, as originally proposed by Ross (1977) and extended to the insurance literature by Hsueh and Liu (1990), Akhigbe, Borde, and Madura (1993), and, more recently, Staking and Babbel (1995), suggests that the existence of a corporate veil may lead managers to convey important information to investors and/or other interested parties via signals that may or may not be unambiguous within the context of original intent.

It is within the context of these two fundamental economic theories-selfinterest and signaling-that insurance market pullout announcements are particularly worthy of study. Clearly, insurance companies develop their various products and decide which geographic areas to serve with the intention of earning profits. Indeed, the primary function of actuaries is to ensure that the expected values of insured losses and insurer expenses do not exceed expected premiums and investment income-otherwise, the sharing of risk through insurance is not economically feasible. There are, however, likely to be circumstances in which entire categories of existing insurance products, once expected to be profitable, may actually lead (or be expected to lead) to significant losses. Such problems may arise from a single unprofitable line of coverage, general unprofitability, adverse regulatory changes, or natural disasters. In these instances, insurance companies may rationally choose to withdraw from specific market segments and/or to eliminate entire product lines.

This study investigates a number of important and previously untested hypotheses concerning insurance industry shareholder wealth effects around the time of property-liability insurance company market pullout announcements. Under the assumptions of capital market efficiency, the share price responses of stock insurance companies around the time of public pullout announcements provide wellreasoned insights into the market's unbiased opinion as to the merits and competitive ramifications of the decisions to withdraw.

Just how are insurance company withdrawal announcements interpreted by financial market participants? Do insurance company share prices rise in response to withdrawal announcements, as would be suggested by self-interest theory and the fully voluntary nature of the events? Or, do share prices actually fall as a consequence of the dissemination of potentially negative signals regarding trends in firm- and/or industry-specific insurance markets? Similarly, and perhaps even more importantly from the standpoint of insurance regulation, what are the share price responses of major market competitors of the withdrawing firms? Obviously, the answers to these questions are of significant interest to many constituencies, including insurance company executives, shareholders, governmental regulators, and academic researchers. …

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