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Organisational structure, corporate governance and reinsurance decisions in the U.S. property-liability insurance industry

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Abstract

This paper investigates the impact of organisational structure and corporate governance on reinsurance decisions in the U.S. property-liability insurance industry. Our evidence shows that mutual insurers, mutual-owned stock insurers and stock insurers whose ultimate parent is publicly traded are likely to purchase more reinsurance from non-affiliated reinsurers than stock insurers closely held by managers. We also find that corporate governance significantly influences reinsurance purchases; specifically, CEO/chairperson duality is associated with lower reinsurance purchases while the percentage of independent directors on the board is positively (negatively) related to reinsurance purchases from non-affiliated (affiliated) reinsurers. Higher audit quality is associated with lower (higher) reinsurance purchases from non-affiliated (affiliated) reinsurers. Moreover, many interaction terms between organisational structure and corporate governance have significant effects on reinsurance decisions. Finally, we provide evidence that the Sarbanes–Oxley Act (SOX) has a substantial effect on the relation between organisational structure (corporate governance) and reinsurance decisions. The overall effect of SOX on reinsurance purchase from non-affiliated reinsurers is negative, implying that better investor protection results in higher risk taking and less risk shifting to outside reinsurers.

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Notes

  1. Some studies examine the relation between corporate governance and risk-taking behaviour rather than reinsurance decisions. For example, Cole et al. (2011b) discuss the relation between the separation of ownership and management and risk taking in the U.S. property-casualty insurance industry. They find that the percentage of outside directors is not significantly related to risk taking. Ho et al. (2013) suggest that large board size is associated with higher total risk and higher leverage risk but lower investment risk. Insurers with higher percentages of insiders on their boards tend to have higher total risk. Sekerci and Pagach (2019) find that firms with high agency costs are less likely to favour ERM’s monitoring role.

  2. Risk measures are the variance of return on assets (ROA) and natural logarithm of BCAR.

  3. Only these four corporate governance variables are available for both mutual insurers and stock insurers.

  4. Linck et al. (2009) find that directors’ workload and risk increased post-SOX. Masulis and Mobbs (2011) note that many U.S. boards force firms to increase the number of outside directors or replace officer-directors with outside directors based on legal and regulatory changes such as SOX. Shareholders experience great gains when inside directors acquire outside directorships post-SOX.

  5. Both He and Sommer (2010), Cole et al. (2011b) use stock insurers closely held by managers as the reference group.

  6. Many studies document that insurers use reserve management to manage their earnings (e.g. William et al. 2003; Hsu et al. 2019). These studies also show the importance of stable earnings.

  7. We follow the literature (e.g. Lai et al. 2000; Ho et al. 2013) and exclude insurers with asset size less than USD 100 million. Our sample includes the majority of insurers in the P-L insurance industry. However, our results may not be applicable to smaller insurers. We thank the reviewer for pointing this out.

  8. The sample consists of individual insurers. We manually collect the organisational structure variable and corporate governance variables at the individual insurer level from Best’s Insurance Report. All continuous variables are winsorised at the 1% and 99% level to limit the effects of extreme values. Not all 2018 corporate governance variables were available when we conducted the analysis.

  9. The Hausman test results show that all models’ p-values are significant (less than 5%), and fixed effects are recommended. For example, chi2 and p-value are 473.21(0.000), 264.43 (0.000) and 67.65 (0.0015), respectively, in the models of reinsurance ratio, reinsurance from affiliated insurers and reinsurance from non-affiliated insurers (Panel A in Table 4).

  10. To perform DWH tests, we first calculate the residuals of each potentially endogenous variable. We then include the residuals of each potentially endogenous and all exogenous variables in a regression of the original model. If the coefficient on the residual is significantly different from zero, then OLS is not consistent, suggesting that the variables are endogenous.

  11. Relative size is measured as the percentage of an insurer’s total premiums earned relative to all insurers’ premiums earned.

  12. Cummins et al. (2008) define reinsurance ratio as the premiums ceded to non-affiliated reinsurers.

  13. We include Arthur Andersen in the Big 4 auditors before 2002 because the previous literature covers the Big 5. Arthur Anderson agreed to surrender its CPA licenses and its right to practice on August 31, 2002, and went out of business.

  14. Chen and Yan (2012) use the coastal state dummy variable. They define the variable based on Landscape of Natural Disasters of USATODAY.com.

  15. Cole et al. (2011b) report means of mutual insurers, mutual owned stock, stock closely widely held, stock closely held by management and stock insurers closely held by others from 1996 to 2004 of 0.27, 0.11, 0.49, 0.11 and 0.02, respectively.

  16. The means of reinsurance ratio are 39.43% (Cole et al. 2011a), 40% (Cole et al. 2011b), 38.78% (Chang 2015) and 36.83% (Chang 2019) when using data of the U.S. property-casualty insurance industry.

  17. Cole et al. (2011a) show that the means of reinsurance ratio from affiliated reinsurers and reinsurance ratio from non-affiliated reinsurers are 24.79% and 14.64%, respectively.

  18. The F-statistic and J-statistic results are shown in Appendix A.1.

  19. The F-statistic and J-statistic results are shown in Appendix A.2.

  20. Please note that the impact of SOX on reinsurance may be different for affiliated reinsurance and non-affiliated reinsurance.

  21. The F-statistic and J-statistic results are shown in Appendix A.3.

  22. The F-statistic and J-statistic results are shown in Appendix A.4.

  23. The results are not provided to preserve space. The authors are happy to provide the results upon request.

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Authors and Affiliations

  1. Department of Risk Management and Insurance, Tamkang University, 151 Ying-Chuan Road, Tamsui, New Taipei City, 251, Taiwan

    Chia-Ling Ho

  2. Department of Finance, Belk College of Business, The University of North Carolina at Charlotte, 9201 University City Blvd., Charlotte, NC, 28223, USA

    Gene Lai

  3. Department of Non-Life Insurance Research, Korea Insurance Research Institute, 38 Gukjegeumyung-ro 6-gil, Youngdeungpo-gu, Seoul, Korea

    Sangyong Han

  4. School of Insurance, Southwestern University of Finance and Economics, 555 Liutai Ave., Chengdu, 611130, Sichuan, China

    Licheng Jin

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  1. Chia-Ling Ho
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Appendix

Appendix

A.1: Results for the F-statistics and J-statistics shown in Table 4

CEO/chairperson duality is an endogenous variable in three models (i.e. models of total reinsurance ratio, affiliated reinsurance ratio and non-affiliated reinsurance ratio). The F-statistics for the IV relevance test are 3.942, 3.886 and 3.886 (3.692, 3.629 and 3.629) in Panel A (Panel B), respectively, significant at the 1% level. The evidence indicates that our IVs are relevant. The J-test statistics for the IVs are 1.178(0.555), 1.226(0.542) and 0.825(0.662) in Panel A and 1.327(0.515), 1.305(0.521) and 1.508(0.470) in Panel B, suggesting they are insignificant at the 1% level. The results indicate there is no over-identification for the IVs. Board size is an endogenous variable in three models. The F-test statistics for the IV relevance test are 6.030, 6.033 and 6.033 (6.692, 6.696 and 6.696) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 9.489(0.500), 10.781(0.560) and 5.477(0.242) in Panel A and 9.959(0.411), 10.223(0.368) and 5.540(0.236) in Panel B, suggesting they are insignificant at the 1% level. The percentage of independent directors on the board is an endogenous variable in three models. The F-test statistics for the IV relevance test are 5.775, 5.676 and 5.676(6.321, 6.254, and 6.254) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 6.065(0.194), 9.061(0.596) and 4.633(0.327) in Panel A and 6.326(0.119), 9.559(0.486) and 4.187(0.381) in Panel B, suggesting they are insignificant at the 1% level. The Big 4 auditor is an endogenous variable in three models. The F-test statistics for the IV relevance test are 14.931, 14.961 and 14.961 (13.445, 13.477 and 13.477) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 0.208(0.902), 0.163(0.922) and 0.924(0.630) in Panel A and 0.292(0.864), 0.256(0.879) and 0.850 (0.654) in Panel B, suggesting they are insignificant at the 1% level.

A.2: Results for the F-statistics and J-statistics shown in Table 5

Organisational structure is an exogenous variable in all models. CEO/chairperson duality is an endogenous variable in three models. The F-statistics for the IV relevance test are 3.752, 3.686 and 3.686 (3.714, 3.648 and 3.648) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics are 0.919(0.631), 0.921(0.631) and 0.916(0.633) in Panel A and 0.760(0.684), 0.761(0.684) and 0.792(0.673) in Panel B, suggesting they are insignificant at the 1% level. Board size is an endogenous variable in three models. The F-test statistics for the IV relevance test are 5.985, 5.988 and 5.988 (6.333, 6.337 and 6.337) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 9.018(0.607), 10.238(0.366) and 4.789(0.309) in Panel A and 8.856(0.648), 10.449(0.335) and 5.191(0.268) in Panel B, suggesting they are insignificant at the 1% level. The percentage of independent directors on the board is an endogenous variable in three models. The F-test statistics for the IV relevance test are 5.329, 5.312 and 5.312(5.087, 5.068 and 5.068) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 7.571(0.109), 8.651(0.704) and 6.616(0.158) in Panel A and 7.408(0.116), 8.473(0.757) and 6.919(0.140) in Panel B, suggesting they are insignificant at the 1% level. The Big 4 auditor is an endogenous variable in three models. The F-test statistics for the IV relevance test are 16.064, 16.095 and 16.095 (14.984, 15.009 and 15.009) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 0.320(0.852), 0.247(0.884) and 1.141(0.565) in Panel A, and 0.148(0.929), 0.093(0.954) and 0.860(0.650) in Panel B, suggesting they are insignificant at the 1% level.

A.3: Results for the F-statistics and J-statistics shown in Table 6

Organisational structure is an exogenous variable in all models. CEO/chairperson duality is an endogenous variable in three models. The F-statistics for the IV relevance test are 6.179, 6.112 and 6.112, (6.202, 6.137 and 6.137) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 2.978(0.226), 2.948(0.229) and 3.326(0.189) in Panel A and 3.430(0.180), 3.342(0.188) and 4.189(0.123) in Panel B, suggesting they are insignificant at the 1% level. Board size is an endogenous variable in three models. The F-test statistics for the IV relevance test are 3.589, 3.588 and 3.588 (4.041, 4.042 and 4.042) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 5.734(0.219), 5.024(0.285) and 5.934(0.204) in Panel A and 6.406(0.171), 5.395(0.249) and 5.624(0.229) in Panel B, suggesting they are insignificant at the 1% level. The percentage of independent directors on the board is an endogenous variable in three models. The F-test statistics for the IV relevance test are 5.432, 5.319 and 5.319 (6.437, 6.349 and 6.349) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 8.841(0.652), 7.867(0.810) and 4.289(0.368) in Panel A and 8.041(0.111), 7.517(0.711) and 4.684(0.321) in Panel B, suggesting they are insignificant at the 1% level. The Big 4 auditor is an endogenous variable in three models. The F-test statistics for the IV relevance test are 20.293, 20.336 and 20.336 (17.415, 17.451 and 17.451) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 0.014(0.993), 0.037(0.982) and 0.380(0.918) in Panel A, and 0.171(0.918), 0.210(0.900) and 0.254(0.881) in Panel B, suggesting they are insignificant at the 1% level.

A.4: Results for the F-statistics and J-statistics shown in Table 7

Organisational structure is an exogenous variable in all models. CEO/chairperson duality is an endogenous variable in three models. The F-statistics for the IV relevance test are 6.266, 6.194 and 6.194 (5.529, 5.465 and 5.465) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 2.494(0.287), 2.449(0.294) and 2.932(0.231) in Panel A and 2.634(0.268), 2.604(0.272) and 2.994(0.224) in Panel B, suggesting they are insignificant at the 1% level. Board size is an endogenous variable in three models. The F-test statistics for the IV relevance test are 3.385, 3.383 and 3.383 (3.572, 3.573 and 3.573) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 6.371(0.173), 5.836(0.212) and 5.409(0.248) in Panel A, and 5.943(0.204), 5.573(0.233) and 5.483(0.241) in Panel B, suggesting they are insignificant at the 1% level. The percentage of independent directors on the board is an endogenous variable in three models. The F-test statistics for the IV relevance test are 4.633, 4.618 and 4.618 (4.419, 4.393 and 4.393 in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 6.984(0.137), 9.056(0.597) and 4.915(0.296) in Panel A, and 6.808(0.146), 8.814(0.659) and 5.208(0.267) in Panel B, suggesting they are insignificant at the 1% level. The Big 4 auditor is an endogenous variable in three models. The F-test statistics for the IV relevance test are 19.313, 19.355 and 19.355 (14.629, 14.675 and 14.675) in Panel A (Panel B), respectively, significant at the 1% level. The J-test statistics for the IVs are 0.018(0.991), 0.038(0.981) and 0.102(0.950) in Panel A, and 0.032(0.984), 0.045(0.978) and 0.119(0.942) in Panel B, suggesting they are insignificant at the 1% level.

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Ho, CL., Lai, G., Han, S. et al. Organisational structure, corporate governance and reinsurance decisions in the U.S. property-liability insurance industry. Geneva Pap Risk Insur Issues Pract 47, 737–784 (2022). https://doi.org/10.1057/s41288-021-00238-2

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