Summary
In this article it is shown that in the presence of guaranty funds that charge a non-risk-adjusted premium-based assessment, the riskiness of the policyholder loss distribution affects insurance company organizational structure. Heterogeneity in consumer riskiness creates incentives for a separate insurance firm for each consumer type. The result follows because forming separate firms maximizes the benefit to shareholders of the mispriced guaranty fund insurance. The results suggest that mispriced guaranty fund assessments may create incentives not only for riskier asset portfolios or riskier reserving practices, as has been previously suggested, but may also influence insurance company organizational form. The results provide a possible explanation for the empirical phenomenon of property-liability insurance fleets, which feature separate companies under a common ownership.
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Extract
The Organizational Structure of Insurance Companies: The Role of Heterogeneous Risks and Guaranty Funds
One of the peculiarities of organizational form within the insurance industry is the presence of a large number of separate insurance companies within a single overarching parent organization. These groups or fleets, as they are known within the industry, would appear to offer less protection against insolvency risk than a single multiline insurance company, since, of necessity, they would have a smaller pool of equity capital in each company than a combined enterprise. The grouping phenomenon is quite strong in the property-liability industry. Curnmins and Weiss (1991, p. 122) note that although there were approximately 3,000 property-liability insurance companies in the United States as of 1989, "only 1900 firms play a significant role in the market and 1300 of these are clustered together in approximately 340 insurance groups under common ownership."
Vaughan (1997, p. 226) notes that insurance company groups originally developed in response to legal constraints. For example, fire companies were forbidden to write casualty coverage and vice versa. A natural response to this leg...See the full content of this document
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