Stock Versus Mutual Ownership Structures - The Risk Implications

Stock Versus Mutual Ownership Structures: The Risk Implications
Author(s): Joan Lamm-Tennant and Laura T. Starks

Source: The Journal of Business, Vol. 66, No. 1 (Jan., 1993), pp. 29-46
Published by: The University of Chicago Press
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Joan Lamm-Tennant
Villanova University
Laura T. Starks
University of Texas at Austin
Stock versus Mutual Ownership

Structures: The Risk
Implications*
I.
Introduction
As early as Berle and Means (1932) and Coase

(1937), researchers have been interested in the
relation between the firm's activities and the
structureof its property rights. This line of researchhas continuedin the analysis of the rights
of the contractingparties within a firm's organization and their effects on managerialand owner
activities(Alchianand Demsetz 1972;Jensen and
Meckling1976;Fama and Jensen 1983a, 1983b).
A particulararea of interest has been in the differences in property rights associated with the
mutualform of organizationversus the corporate
form. A mutualorganizationis one in which the
customers are also the owners (residual claim
holders). This is in contrast to the stock organization in which there is a separation between
owners and customers.
This article provides

empiricaltests of the
risk differencesbetween two types of
ownershipstructurein
the property-liabilityinsuranceindustry. Empirical evidence is pro-
vided that suggests

stock insurershave
more risk than mutuals
where the risk inherent
in future cash flows is
proxied by the variance
of the loss ratio. Further evidence suggests
that stock insurers
write relatively more
business than do mutuals in lines and states
having higherrisk.
* This researchwas funded in part by the S. S. Huebner

Foundationfor Insurance Education of the University of
Pennsylvaniaandby the Universityof Texas at Austin,Graduate School of Business. We appreciate the constructive
commentsoffered by P. Laux, C. Barry, D. Brown, J. D.
Cummins,J. Garven,S. Gilson, J. Golec, J. Karpoff,J. Martin, D. Mayers,R. Rao, A. Senchack,C. Smith,R. Witt, and
participantsof workshopsat the University of Arizona, the
Universityof New Mexico, and the WhartonSchool at the
Universityof Pennsylvania.In particular,we are gratefulto
R. Wittand the Gus S. WorthamMemorialChairin Risk and
Insuranceat the University of Texas at Austin for making
availablethe A. M. Best data tapes and to G. Niehaus and
N. Dohertyfor their valuablecomments. We would also like
to thankan anonymousrefereefor manyhelpfulsuggestions.
(Journal of Business, 1993, vol. 66, no. 1)
? 1993 by The University of Chicago. All rights reserved.
0021-9398/93/6601-0002$01.50
29

30
Journal of Business
Empiricalliteratureaddressingownership structurehas continually

experienced problems in developing hypotheses as a result of the endogenous nature of ownership structure. Ownershipstructurehas an
effect on the firm's decision-makingprocess, while the firm's environment helps determine the appropriateownership structure. Although
some researchers investigate ownership structurefrom a broad perspective (Demsetz 1983; Demsetz and Lehn 1985), others employ an
industryspecific approach(Mayers and Smith 1981, 1982, 1986, 1988,
1990a, 1990b, 1992;O'Hara 1981;Wolfson 1983;Smith 1986;Karpoff
and Rice 1989; Garven 1990; Saunders, Strock, and Travlos 1990).
Given the endogeneity of ownership structure, the industry-specific
approachhas the advantage of naturallycontrollingfor many of the
confoundingvariables.
Our article investigates the relation between ownership structure
and firmenvironmentin the property-liabilityinsuranceindustry.This
industryis particularlyappropriatesince diverse forms of ownership
coexist across all lines of business. Explanationsfor this coexistence
have been based on agency problems (Fama and Jensen 1983a, 1986;
Mayers and Smith 1988, 1990b), adverse selection problems (Smith
and Stutzer 1990), and the efficiency of risk-sharingarrangements
(Doherty and Dionne 1988; Doherty 1991). Although each of these
explanationsimplies that the risk activities of mutualinsurerswill differ from that of stock insurers, the agency and adverse selection theories imply that the mutualinsurershould be associated with less risky
activities than the stock company, while the efficientrisk-sharingargument implies that the mutual insurer should be involved in insuring
morerisky clients. We test these implicationsby examiningdifferences
in risk characteristicsof stock versus mutualinsurancecompanies.
This article is organizedin the following manner.The risk implications of hypotheses concerning the coexistence of mutual and stock
insurancecompaniesare discussed in Section II, followed by a descriprtion of the data set in Section III. The analyses in Sections IV, V,
and VI are directed toward identifyingdifferences between stock and
mutualinsurersregardingbusiness concentrationand risk. In the first
of these analyses (in Sec. IV), we address firm-specificmeasures of
risk and, using a conditionallogit model, test for a significantrelation
between organizationaltype and risk. We find that stock insurersare
associated with riskier cash flows when risk is measuredby the variance of the loss ratios. In Section V we evaluate stock and mutual
insurerson a by-line basis and find that stock insurersare more concentrated in the riskier lines of business than are mutual insurers.
Similarly,in Section VI, we evaluate stock and mutualinsurersacross
geographicareas. We find stock insurers to be more concentratedin
those states with higher variances of loss ratios. Finally, our conclu-

31
sions and recommendationsfor furtherresearch are presented in Section VII.

II. Hypotheses regarding Risk Differences between Stock and Mutual
Insurers
Mayers and Smith (1981, 1986, 1988, 1990b, 1992)and Fama and Jensen (1983a, 1983b) argue that the survival of both the corporate and
the mutualform of organizationis due in partto the relativeefficiencies
of these differentforms in controllingagency problems. With regard
to insurers,these agency problemsarise because of the threefunctions
inherentin the organizations;managerial,owner/riskbearer, and customer/policyholder.Alternate ownership structures in the insurance
industry combine these functions in different ways. Stock insurers
are characterizedby the potentially complete separationof all three
functions while mutualinsurers merge the policyholderwith the ownership function.'
Mayers and Smith (1981, 1986, 1988, 1990b, 1992)have developed
the consequences of agency conflicts between policyholdersand owners and between owners and managersfor the life insuranceindustry
and the property-liabilityinsurance industry. Under their managerial
discretion hypothesis, the difference in costs of controllingincentive
conflictsbetween owners and managersas well as between policyholders and owners influencesthe choice between the stock or mutualform
of organization.Mayers and Smith point out that the more decision
authorityagents have, the greaterthe potentialfor them to operate in
their self-interest at the expense of owners. Mutualmanagerstend to
have greaterdecision authoritythan do stock managersbecause of the
less effective marketfor corporatecontrol. Mayers and Smith predict
that the costs of controllingmanagementare significantlyhigher and
the benefits smaller for mutuals as compared to stock firms. Consequently they hypothesize that, if the cost of controllingmanagement
in mutual insurance firms is higher than in widely held stock firms,
then mutualsshouldbe more prevalentin lines of business where managementexercises little discretion. Likewise, stock insurersshould be
observed more frequently in lines where managementdiscretion is
more important.
Also employing the agency paradigm, Fama and Jensen (1983a,
1983b)discuss the separationof the risk-bearingand decision functions
in financialmutuals in general. Because of the differences in efficien1. It should also be noted that a nonparticipatingpolicyholderis similarto a debt
holder. The policyholderhas a liability claim on the insurancecompany. Thus, the
agency problemsdiscussed in the finance literaturebetween debt holders and owners
also exist between policyholdersand owners.

32
Journal of Business
cies of controllingagency costs, Fama and Jensen predictthat mutuals

should be more prevalentin activities in which the costs of expanding
and contractingassets is lower and in which the costs of valuingthose
assets are lower. An additionalempiricalimplicationthey posit is that
financialstock companies should be associated with more uncertain
future cash flows than should financialmutualcompanies.
The Smith and Stutzer (1990) analysis focuses on the differences
between two types of insurancepolicies, participatingand nonparticipating. With participatingpolicies the price of the insurance is determined ex post. Consequently, the insured shares in the overall
operating risk of the insurance company. In contrast, with nonparticipatingpolicies the price of the insuranceis determinedex ante
and the insured does not share in the overall operating risk. Given
the adverse selection probleminherentin insurance,coupled with the
existence of aggregate(undiversifiable)risk, Smithand Stutzerdevelop
a model in which they show the coexistence of both types of policies
in equilibrium.They furtherdemonstratethat participatingpolicies will
be purchasedby low-risk insuranceconsumerswhile nonparticipating
policies will be purchasedby high-riskinsuranceconsumers. The mutual form of organizationis in effect a participatingpolicy since the
policyholdershave the residualclaims. Althoughstock insurancecompaniescan issue participatingpolicies, the majorityof property-liability
policies they issue during our sample period are nonparticipating.
Thus, the empirical implication is that, on average, mutual insurers
will cover lower-riskpolicyholdersthan will stock insurers.2
Doherty and Dionne (1992) and Doherty (1991) have a similarline
of argumentto Smith and Stutzer (1990) althoughtheir conclusion is
at variance with the latter's. Doherty and Dionne concentrate their
analysison differencesin the efficiency of risk sharingbetween participatory and nonparticipatorypolicies. Specifically, they argue that,
when risk is not easily diversifiable, combining policy and equity
claims into a single package is a more efficient risk-sharingarrangement than a simple prepaid risk transfer. There are various methods
for assemblingthe policy/equity package-through organizationaldesign as in a mutualinsurancecompany, througha participatingpolicy,
or throughhomemademutualization(buyingstock in an insurancefirm
and buying a policy from that firm). Doherty and Dionne suggest that
since the policy/equity package offered by the mutual is a more efficient risk-sharingarrangementthan can be attainedby a stock insurer
(without a participatingpolicy), the mutual should write insurance in
high-risklines more effectively than the stock insurer.
2. If stock insurers had issued a largernumberof participatingpolicies duringthe
sampleperiod, then the empiricalimplicationwould be for less of a differencebetween
the risk activitiesof mutualand stock insurers,and our null hypothesisof no difference
wouldbe more difficultto reject.

33
All four of these hypotheses have implicationsfor the risk-bearing

activities of the mutual versus the stock insurance company.3 The
theoriesof Fama and Jensen (1983b), Mayersand Smith(1990b, 1992),
and Smithand Stutzer (1990)imply that stock insurersshouldbe associated with the more risky insurance activities, while Doherty and
Dionne imply that mutuals should be associated with the more risky
activities. Thus, there exists an empiricallytestable difference in the
risk implicationsof these theories. Note, however, that the different
hypotheses have implicationsfor differentmeasures of risk.
Accordingto the Fama and Jensen (1983b)argument,the risk implication is that mutual insurers should be associated with activities
where future net cash flows are more certain. One would expect the
mutualinsurerto be associated with an aggregatemix that is less risky
than that of the stock insurer. Thus, to test this implicationwe need
a risk measure that captures the riskiness of future net cash flows on
a total firm basis. In contrast, if Smith and Stutzer's (1990) adverse
selection hypothesis is true, then the unit of analysis should be line of
business. That is, we should observe mutualinsurersassociated with
the less risky policies. Smith and Stutzer point out that such a test
shouldbe performedby line of business because aggregatedata would
be influencedby the organization'smix of insurancelines.
An appropriatemeasure of risk to capture the implicationsof the
Mayers and Smith (1988, 1990b)hypothesis is less definitive. To test
the risk implicationsof their hypothesis, we need to makean additional
assumption. We assume that the managerialdiscretion requirements
are reflectedby the riskiness of the business income. Then Mayers and
Smith's managerialdiscretion hypothesis also implies that the mutual
insurershould be involved in the less risky activities on eithera by-line
or total firmbasis. Finally, if Doherty and Dionne's (1992)hypothesis
holds, the focus is on undiversifiedrisk, and the implicationis that the
mutualinsurer should be involved in more risky activities on a total
firmbasis.
Since we are interested in risk differentialsbetween stock firmsand
mutualfirms and the accentuation or attenuationof these differences
across lines of business or geographicareas, we need a proxy for risk
that is applicablefor both mutuals and stocks and that allows for risk
measurementby line of business and by geographic area. The best
measurewould use data that reflect marketvalues, but these data are
not availablefor mutualfirms. One measurethat meets these requirements is the varianceof an insurer'slosses. Since there is a difference
3. In the absence of agency, adverse selection, and efficientrisk-sharingproblems,
Garven(1992)examines the differencesin risk incentivesfor mutualand stock insurers
caused by the existence of asymmetrictaxes combinedwith limitedliability.The implication of his analysis is that mutualinsurershave greaterdisincentivesfor risk bearing
thando stock insurers.

34
Journal of Business
in size across insurance companies, we also need a measure of risk

that normalizes for the size of business. Given these considerations,
we proxy the risky activities of the insurer as the variance of losses
normalizedfor size-the variance of the loss ratio.
The loss ratio (losses incurred/premiumsearned)representsthe percent of premiums earned necessary to cover losses incurred.4One
minus the loss ratio would represent premiumsearned that are available to cover expenses (both operatingexpenses and loss adjustment
expenses) and to contributeto underwritingprofits.Since the loss ratio
does not includeexpenses, it is not a complete measureof profitability.
However, this is not a severe limitation because the profit ratio has
been found to be highly correlated with the premium-to-claimratio.
(See Cumminsand Nye 1980.) Further, insurers do not allocate expenses to individualstates. Consequently,we ignoreexpenses and use
the variabilityof the loss ratio as an ex post measureof the underwriting risk in a certain line of business or state.
The variance of the loss ratio should be highly correlatedwith the
uncertainty of future net cash flows posited by Fama and Jensen
(1983b) and with the riskiness of business income that we assume is
associated with managerialdiscretion requirementsas described by
Mayers and Smith (1988, 1990b, 1992). The risk referredto by Smith
and Stutzer (1990)is policyholderrisk; that is, their hypothesis implies
that, on a by-line basis, the mutual insurer should be associated with
the lower-risk policyholders (i.e., those with lower expected losses).
However, Smith and Stutzer point out that, undercertain(reasonable)
conditions, the additionalimplicationholds that the varianceof losses
for the mutualinsurershould be lower thanfor the stock insurer.Thus,
our measure is appropriatefor testing the implicationsof their theory
providedthe additionalconditions exist.
The Doherty and Dionne (1992) hypothesis is strictly applicableto
nondiversifiableunderwritingrisk ratherthan total risk as reflectedby
the varianceof the loss ratio. However, if we test the risk implications
on a sample of large consolidated groups and large independentinsurance firms that write policies across lines and geographicareas, then
there is a considerable amount of risk pooling, and the correlation
between nondiversifiablerisk and total risk should be high.
Hypotheses concerningdifferencesbetween mutualand stock property-liabilityinsurancecompanies have been tested by Fama and Jensen (1983b), Mayers and Smith (1990b, 1992), and Smith and Stutzer
4. Premiumsearned are equal to the premiumswrittenin a year (i.e., income from
policies sold) adjusted for the change in the unearnedpremiumreserves. Unearned
premiumreserves are established to account for the fact that premiumsare paid in
advancebut not actuallyearnedwithoutthe passage of time. Losses incurredare equal
to losses paid adjusted for the change in loss reserves. Loss reserves represent an
actuarialdeterminationof futurelosses.

35
(1990).Fama and Jensen (1983b)find that the percentageof long-term

nonfinancialassets to total assets is lower for mutualinsurancecompanies than for stock insurance companies. This evidence is consistent
with their hypothesis that the corporatefinancialorganizationsshould
be more involved in business activities other than managementof financial assets. Their evidence concerning business receipts as a percentageof total receipts is not supportiveof theirhypothesis, however.
In this case the percentagebusiness receipts (revenueother than interest, dividends, and capital gains) for mutual insurance companies is
greaterthan for stock insurance companies.
Mayers and Smith (1990b, 1992)test their managerialdiscretionhypothesis in both the property-liabilityindustry and the life insurance
industry. In the first test (Mayers and Smith 1990b)they employ the
percentage of premiums business in the 26 lines of insurance as a
measureof production-allocation.They find significantcross-sectional
differences in production-allocationpatterns across lines of business
for the ownershipstructuresthat they investigate(closely held stocks,
widely held stocks, mutual-owned stocks, and association-owned
stocks). They conclude that this evidence is consistent with their hypothesis. Their study of executive compensationin the life insurance
industry(Mayers and Smith 1992)provides strongerevidence in support of the managerialdiscretion hypothesis. Specifically, they find
that the compensationof mutuallife insuranceexecutives is lower and
less responsive to firm performance than that of stock companies.
These results are consistent with the implication of the managerial
discretionhypothesis that the value of the marginalproductof mutual
insurancecompany executives should be lower than that of the,stock
insurancecompany executives.
Smith and Stutzer (1990) test their risk difference hypothesis using
6 years of claims data from a single line (medical malpractice)in one
state (Minnesota) for two companies, a mutual insurer and a stock
insurer. The evidence supports their hypothesis in that they find that
the mutualinsureris associated with the less risky claims (i.e., lower
loss payments per claim).
Ourempiricaltests of the risk differencesbetween mutualand stock
insurersare more powerfuland more direct than the existing evidence.
Our data set covers 95% of the assets in the U.S. property-liability
insurance industry over an 8-year period. In addition, our risk measures are more comprehensive. We have a longer time period, and for
each company we use an aggregaterisk measure and additionalrisk
measures decomposed by line of business and geographicareas. This
empiricalevidence of the differences in risk characteristicsof mutual
versus stock insurance companies is important.It allows for assessment of the agency cost, adverse selection, and efficient risk-sharing
hypotheses as explanationsof ownershipstructure.Althoughprevious

Journal of Business
36
empiricalresearch has provided evidence on differences between the

stock and mutual organization along several dimensions, it has not
offered such direct evidence concerningthe differencesin risk characteristics between the two organization types as we provide in this
article.
III. Data and Method
To test our hypotheses we obtain data on property-liabilityinsurance

companies from the A. M. Best data tapes for 1980-87. We use a
subset of all firms by including only group insurers and independent
insurers.5This subset accounts for over 95% of the total assets of all
property-liabilityinsurers. We use the groupratherthan the individual
companieswithinthe groupbecause the grouprepresentsa more accurate picture of the ownership structureof the total firm. In particular,
since we are interested in risk and its diversificationacross lines of
business, using groupinsurersprovides for a more complete analysis.6
The number of groups and independent companies in our sample
rangesfrom 240 in 1980to 251 in 1987.The majorityhave either stock
or mutualownership structures.For example, the initial 1985data set
includes 140 stock firms, 94 mutuals, 1 Lloyds, and 15 reciprocals.7
Our interest is in the differences between the stock and mutualforms
of organization.Thus, we include only firms that meet the following
criteria:(1) the ownership structureis either stock or mutual;(2) the
stock firm is a "pure" stock firm (i.e., its shares are not owned by a
mutualorganization);(3) the insurer'sownershipstructurecan be verified; and (4) there is continuous data for the firmover the 8-year time
period. The ownershipof each of the firmsis verifiedthroughMoody's
Bank and Finance Manual or through Best's Insurance Reports. We
also check and correct for erroneous identificationof ownershiptype

on the data base. After meetingthese criteria,our finalsampleconsists,
of 79 stock insurersand 91 mutualinsurers.Althoughthis sampledoes
not contain all mutual and stock property-liabilityinsurers, it covers
the majorityof all policies written and should thereforebe representative of the full data set. Premiumsearned and losses incurreddata are
availablefor these firms on a total firmbasis as well as across 26 lines
of business and over 50 geographic areas. The classifications of the
lines of business are based on statutoryaccountingpractices.
5. An insurancecompanygroupis an organizationof insurersoperatingin a holding
companyenvironment.
6. Our remainingreferencesto companiesor firmstreat a groupas a single firm.
7. A reciprocalinsurancefirmis similarto a mutualin that the policyholdersown the
firm,but they differfrom a mutualin terms of legal controland capitalrequirements.A
Lloyds firmis similarto stock in that the residualclaim holdersassume the risk, but it
is a proprietaryratherthan corporateform.

37
IV. Risk Analysis across Companies
We first test our hypothesis by examiningaggregaterisk measuresfor

each companyin our finaldata set. To test whethertotal risk is related
to organizationaltype, we need to control for size. We run a set of
logistic regressions of the following form:
log[Pi1(I - Pi)] = ao + ajSize1 + a2Riski + ei,
Pi = probability that the organizationalform is the mutual

form,
Sizei = relative size of the company in relationto all companies
in our sample,
Riski = the firm's total risk (measuredas variance of the firm's
loss ratio), and
ej = an error term.
A logistic regression model with maximum-likelihoodestimation is

chosen primarilybecause the independentvariables are not normally
distributed.(See Press and Wilson 1978; or Lo 1986.) However, we
still have the problemthat the risk measureshave skewed distributions
for our data set. Since a variance cannot be negative, the total risk
measurehas a minimumboundaryof zero, but there is no upperbound.
Because extreme observations could unduly influence the results of
the logistic regressions, we conduct the regressions by rankingtotal
risk without omittingobservations. By ranking,we remove the skewness of the distribution. We then run the logistic regression on the
ranks.
The results of this regression are reported in table 1. Organization
type is significantlyrelated to both the variance of the loss ratio and
relative size of the insurer. Thus, we conclude that, after controlling
for the fact that stock insurersare in generallargerthan mutualinsurers, the stock insurers have more total risk (as measuredby the variance of firmloss ratios) than do mutuals.This result is consistent with
the implications of the agency cost hypotheses of Fama and Jensen
(1983b)and Mayers and Smith (1990b, 1992)and the adverse selection
hypothesis of Smith and Stutzer as to the riskiness of insurers' activities.
This test of the four hypotheses focuses on the riskiness of future
net cash flows on a total firm basis. The Smith and Stutzer adverse
selection hypothesis refers to insurers'losses accordingto line of business. Similarly,the Mayers and Smith(1990b, 1992)managerialdiscretion hypothesis also implies restrictionson the line of business. Before
turningto an examination of the risk of cash flows broken down by
line of business, we further investigate how total risk is related to
alternativemeasures of business activity.

38
TABLE 1
Journal of Business
Logistic Regression of Organization Type (Mutual = 1) on Risk and
Size for 170 Insurers
Variable
Parameter
Estimate
Standard
Error
X2
Probability
Intercept
Risk
Size
1.0917
-.0088
-.7909
.3533
.0032
.3861
9.55
7.48
4.20
.002
.006
.040
NOTE.-Riskis measuredas the varianceof a firm'stotal loss ratio,rankedacross all firmsin the
sample. Size is measuredas the percent of a firm's total premiumsearned relative to all firms'
premiumsearned. The size variable is then averagedby firm across the 8-year sample period,
1980-87. Logistic R-statistic = .174.
Panel A of table 2 contains the distributions for the total risk across
insurance companies, and panel B details the correlations between
firm total risk and other firm variables. The distributions for total risk
indicate that stock firms on average have higher variance of loss ratios
than do mutual firms. This is also evident from examining the medians.
Stock firms have a median total variance of .5%, while mutual firms
have a median total variance of .3% The difference is significant at the
.05 level. These results are consistent with our logistic regression results where we control for firm size.
The correlations in panel B indicate that there is no significant relation between the total risk of a firm and its size or the number of lines
in which it is involved, but there is a significantly positive correlation
between total risk and the number of regulatory areas or states in
which a firm is involved.8 If risk is a proxy for the amount of managerial discretion required, this result is consistent with Mayers and
Smith's (1990b) statement that the more widespread a firm's operations, the greater the managerial discretion required.
The correlations reported in panel B also indicate that larger firms
are involved in more lines of business and across more states and that
stock firms are significantly larger than mutuals. As might be expected
from these two results, stock firms have operations across more lines
of business, states, and regulatory areas.
V. Risk Analysis across Lines of Business
According to the agency theory and adverse selection arguments, mutual organizations should be involved in the less risky lines of business.
On the contrary, the efficient risk-sharing hypothesis suggests that
mutuals have a comparative advantage in offering the most risky policies. One measure of risk bearing is the concentration of premiums
8. The states can be grouped into eight areas accordingto the regulatoryprocess
withinthat area. Furtherdiscussion of this classificationis providedin Sec. VI.

39
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Journal of Business
40
earnedfor stocks versus mutualsin the various lines of business. We

test whether that concentrationis related to the riskiness of the lineloss ratios.
Table 3 shows, by organizationtype, the medianacross firmsof the
proportionof a firm's premiumsearned in each line. Given that most
property-liabilityinsurance policies sold are in the two automobile
insurancelines, it is not surprisingthat the highest concentrationfor
both stock and mutual organizationsoccurs in these two lines. The
average across our 8-year sample period is 28.35%of stock insurers'
premiumsearned in the two automobilelines comparedto 47.66%of
the mutualinsurers'premiums.For each line of business, evidence is
providedin table 3 on the difference between concentrationby stock
firmsand concentrationby mutuals. As can be seen, using the normal
approximationto a two-samplemediantest, the differenceis significant
at least at the .05 level for 10 of the 26 lines. Six lines have higher
proportionalconcentration by stock companies and four lines have
higherproportionalconcentrationby mutualorganizations.9If we examine these 10 lines and performa test on the differencebetween the
medians of the standarddeviations of the loss ratios for those lines
dominatedby stocks versus those lines dominatedby mutuals,we find
a significantdifference (at the .04 level) between the standarddeviations of the two groups. In fact, the total risk is more than twice as
highfor the lines dominatedby stock firms(medianstandarddeviation,
.106) than for the lines dominatedby mutual firms (median standard
deviation, .047). Further,this result holds when all lines are considered
in the analysis. The Spearman's rank correlationbetween the 26 Zstatistics for concentrationlevel in table 3 and the standarddeviations
of the line loss ratios is -.488, which is significantat the .012 level.
Thus, examiningthe variance of loss ratios across lines of business
we find evidence of significantlymore risk bearingby stock insurers
than by mutualinsurers. We also find that stock firms have relatively
more business in the lines that have the greatest total risk. It should
also be noted that, although mutuals sell policies in fewer lines of
business thando stocks, the mutualsare not significantlymore concentratedthan are stocks.
VI. Risk Analysisacross GeographicAreas
We next examine the risk of the insurer's cash flows broken down
by geographic area. Geographicareas may differ in their regulatory
environmentand their loss experience. Thus, stock and mutualfirms
that operate in the different states may differ in the risk of their cash
9. There does not appearto be any relationbetween which ownershiptype has more
concentrationand whetherthe contractis short-or long-tailed.

41

TABLE 3
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*
Line
Lines with more statistically significant concentration by mutuals:
3 Farm owners multiple peril
4 Home owners multiple peril
16 Auto liability
17 Auto physical damage
Lines with more statistically significant concentration by
stocks:
7 Inland marine
10 Earthquake
14 Workers compensation
15 Other liability
19 Fidelity
20 Surety
Lines with no significant difference in concentration between
stocks and mutuals:
1 Fire
2 Allied lines
5 Commercial multiple peril
6 Ocean marine
8 Miscellaneous
9 Medical malpractice
11 Group accident and health
12 Credit accident and health
13 Other accident and health
18 Aircraft
21 Glass
22 Burglary and theft
23 Boiler and machinery
24 Credit
25 International
26 Reinsurance
Median
Two-Sample Test
(Normal Approximation)
Z
Prob > Z
Stock
Mutual
.26
6.29
15.94
12.41
1.57
13.21
27.47
20.19
4.02
4.33
3.56
2.13
.0001
.0000
.0004
.0329
2.40
.07
13.57
6.51
.13
1.01
1.43
.02
6.66
2.37
.06
.05
- 2.69
-2.93
-2.96
-3.94
-3.42
- 5.79
.0071
.0034
.0030
.0001
.0006
.0000
2.67
1.14
5.65
.48
.00
.28
.93
.59
.20
.30
.02
.06
.02
.03
.07
.99
2.89
1.19
4.60
.29
.00
.01
.79
.07
.16
.23
.01
.05
.00
.02
.09
1.06
.66
.76
- .51
- 1.20
.41
- 1.51
.43
- 1.19
-.18
-.15
.20
- 1.30
- 1.20
- 1.31
.50
- .30
.5085
.4473
.6101
.2294
.6818
.1299
.6637
.2353
.8533
.8831
.8438
.1929
.2313
.1908
.6156
.7650
* Indicatesthe medianacross firmsof the percentof the firm'stotal premiumsearnedin a line.

The total premiumsearnedin a line were averagedacross the 8-yearsampleperiod, 1980-87.
flows. We first examine the concentrationof business that stocks versus mutualshave in the various states and Americanterritories.10Examiningthe averagepercentageof a firm'spremiumswrittenin a state,
10. In the interest of space, we present the summarystatisticalresults but not the
table providingdetail across the 50 states plus five Americanterritories;these statistics
are availablefrom the authors.

42
Journal of Business
we find that 13 of the states and territorieshave significantlyhigher

concentrationof business by stocks than mutuals, while 15 have significantlyhigher concentrationof business by mutuals. For these 28
states and territories,there is a significantlygreaterrisk in those areas
that have higher concentrationby stocks (median standarddeviation
of loss ratio = .085) than those that have higher concentration by
mutuals(median = .055). Testing across all states, a Spearman'srank
correlationbetween the Z-statistic for a state's concentrationlevel by
mutualsand the standarddeviationof the loss ratiofor that state shows
a strong negative correlation (-.521, significant at the .001 level).
Thus, stock firms tend to concentrate in states that have higher total
risk.
Althoughinsurancecompanies are regulatedon a state basis, a discriminatingelement is not necessarily the state but the regulatoryprocess that prevails within the state. We group the 50 states plus the
District of Columbiaby regulatoryprocess. The state regulatoryenvironmentshave been previously classified into eight classes (Witt and
Miller 1983). Based on the "letter" of the law, three types of state
regulatorylaws were included in the competitive class. States with
competitive rate regulatorylaws basically allow the marketforces associated with supply and demand to determine the equilibriumlevel
of rates. The five types of rate regulatorylaws in the noncompetitive
classificationplace constraints on price competition or interfere with
equilibratingmarketforces. In general, they possess the common trait
of regulatingrates in a mannerthat does not allow the economic forces
of supply and demand to be fully operative. (See the App. for a brief
description of each class.) This classification of regulatory environments has been made specifically for automobileinsurance. Because
of the dominanceof automobileinsuranceand because of the unavailability of by-line, by-state data, we employ this classification as an
instrumentalvariable for the general regulatory environmentwithin
each state."
Table 4 shows, by organizationtype, the averageacross firmsof the
proportionof a firm's premiumsin each of the eight regulatoryareas.
The most concentrationfor both stock and mutualfirmsoccurs in the
priorapprovalregulatoryclass. (This class contains the greatest number of states [24 states]). The table also provides evidence regarding
the significanceof the difference between the concentrationby stock
versus mutualinsurers. The difference is significantat the .1 level or
less for five of the eight regulatoryclasses. Three regulatoryclasses
have more concentrationby stock firmswhile two have more concen11. It should also be noted that, within a regulatorycode, there may be additional
elementsof discriminationdependingon the state's adherenceto its regulatoryprocess.
See Witt and Miller(1983)for furtherdiscussion.

43

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'
Regulatory Area*
(Number of States)
Competitive areas:
1. No-rate regulation (1)
2. No-filing law (3)
3. Information filing (7)
Noncompetitive areas:
4. File and use (10)
5. Modified prior
approval (2)
6. Prior approval (24)
7. Statutory bureau (1)
8. State-made rates (2)
Stock Mutual
Median
Two-Sample Test
(Normal Approximation)
Z
More Concentrated
Organization Type
in AreaT
Prob > Z
3.55
10.23
12.41
3.59
7.47
10.38
.59
-2.29
- 1.69
.5570
.0219
.0903
...
stock
stock
10.04
10.11
1.24
.2158
...
3.39
35.56
1.24
6.93
2.12
51.17
2.34
8.18
-3.39
4.07
1.80
.89
.0007
.0000
.0717
.3748
stock
mutual
mutual
...
Rate regulatoryareas are definedin the App.

* Indicatesthe medianacross firmsof the percentof the firm'stotal premiumsearnedin a rate
regulatoryarea.The totalpremiumsearnedin an areawere averagesacrossthe 8-yearsampleperiod,
1980-87.
+ Indicatesthe organizationtype with the highersignificantconcentration
of business in a state
regulatoryarea.
*
tration by mutual firms. In addition, of the three competitive regulatory

classes, two show more concentration by stock firms.12 Thus, stocks
tend to be more concentrated in the competitive regulatory environments.
The evidence on the risk of cash flows broken down by geographic
area is also consistent with the previous results concerning concentration in lines of business by stocks versus mutuals. As in our line of
business and total firm analyses, the preponderance of the evidence is
consistent with the hypothesis that mutual insurers are associated with
lower levels of risk activities.
VII. Conclusion
According to the agency theory of Mayers and Smith (1988, 1990b,
1992), mutual insurers should be associated with activities that require
less managerial discretion. Assuming that the managerial discretion
requirements are reflected by the riskiness of the business income, the
stock insurers should be associated with the riskier lines of business
and geographic areas. Similarly, according to the agency theory of
Fama and Jensen (1983b) and under certain conditions, the adverse
12. The thirdcompetitiveregulatoryarea consists of only one state.

Journal of Business
44
selection theory of Smith and Stutzer (1990),mutualinsurancecompanies shouldbe associated with less risky futurecash flows. In contrast,
the efficientrisk-sharingtheory of Doherty and Dionne (1992)suggests
that the mutual insurer should be associated with more risky underwritingactivities. This article examines the relation between the risk
of the insurancefirm'sactivities and ownershipstructure.Ourfirsttest
is conducted on a total firmbasis, and we find that stocks have higher
total risk (measuredby the varianceof the loss ratio)than do mutuals.
Furthertests of the hypothesis are disaggregatedby line or by geographicarea and are consistent with our total firmresults. We find that
stock firmshave relatively more business in the lines of business with
the greatest total risk. Furthermore,we find that stocks sell policies
in more lines of business than do mutuals, yet the stocks are not significantlyless concentratedin more lines of business than are mutuals.
The analysis across geographicareas provides results that are consistent with the previous findings-stock firmshave greaterconcentration
in those geographicareas that have the greatest risk.
Appendix
Rate Regulatory Areas13
Competitive Areas
1. No-rate regulatory law. Rates are not controlled by state law

but are subjectto state antitrustlaws. Insurancestatistics are gathered
and analyzedby advisoryorganizations;however, insurersare prohibited from agreeingon rates (contains one state, Illinois).
2. No-filing law. Insurers are not required to file rates with the
regulatoryauthoritiesnor to obtain approval of the rates. Rating bureaus serve only in an advisory capacity. However, the insurancecommissioner has the right to monitor rates on an ex post basis to verify
that rates are reasonable and fair (three states, includes California).
3. Information-filinglaw. This law is similar to the no-filing law
except it requiresthat insurancerates be filed with the state regulatory
authorityfor informationpurposes. Rates are frequentlyput into effect
and later filed with the insurancecommissioner(seven states, includes
Florida).
Noncompetitive Areas
4. File and use law. This law requiresrates to be filedand approved

by regulatoryauthorities. The law is administeredin two ways: (a)
companies may immediately use their own rates, but the rates are
subject to a review and possible disapproval;and (b) a waitingperiod
13 These rate regulatoryareas are definedin Witt and Miller(1980).

45
is imposed before the rates are used to accommodatethe review by

state authorities(10 states, includes Ohio).
5. Modified prior approval law.
This law requires that rates be filed
and approved by state regulatoryauthoritiesprior to implementation

except when there is only a change in rates based on a change in loss
costs (two states).
6. Prior approval law. This law requires that under all circumstances the insurance rate proposed by the insurermust be filed and
approved by the state regulatoryauthoritiesprior to implementation
(24 states, includes Pennsylvania, New Jersey, New York, and
Michigan).
7. Statutory bureau law. This law requires that insurers become
members of a designated rating bureau before receiving licenses to
write insurance within the state. The rating bureau determines the
ratingplan and receives approvalfrom the state regulatoryauthority
(one state).
8. State-made rates. These rates are set by a state agency and
imposed on all insurers. Deviations are frequently permittedcontingent on proof of solvency (two states, Massachusettsand Texas).
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