11

A Study of Exit Forms and Insurer A Study of Exit Forms and Insurer Characteristics: Evidence from the US Characteristics: Evidence from the US

Property/Liability Insurance MarketsProperty/Liability Insurance Markets

American Risk and Insurance Association Conference American Risk and Insurance Association Conference August 5-8, 2007 August 5-8, 2007

Quebec City, CanadaQuebec City, Canada

W. Jean Kwon, Ph.D., CPCU

St. John’s University, New York

Hunsoo Kim, Ph.D.

SoonChunHyang University, Korea

22

Forms of ExitForms of Exit

Life cycle of firmsNormal firms

Merger/acquisition

Voluntary exit

Involuntary exit

Governing lawsGeneral bankruptcy code

Specific provision in the insurance act

Informal actionFormal action

33

Forms of ExitForms of Exit

Normal Firm

FallingFirm Value

Stable/RisingFirm Value

Rehabilitation M&A

VoluntaryLiquidation

Recovery

Status Quo

Recovery

InvoluntaryLiquidation

Financial/OperationalDifficulty

Sound Operation

44

Factors Affecting the Decision ProcessFactors Affecting the Decision Process

Wealth maximization motiveFirm owners and their agents have every incentive to recover their investment capital as much as legally permitted (Peach, 1998).

A firm at a declining stage of business life cycle may form an exit strategy instead of making a further capital commitment (Resnick, 1998).

Policyholder interest protection motive

55

Empirical ExaminationEmpirical Examination

Multinomial logistic (MNL) regression model to get natural log of odd-ratio:

The risk ratio of two probabilities (e.g., voluntary vs. involuntary liquidation)

Xp

plog '

j1k

j

66

Factors Affecting the Decision ProcessFactors Affecting the Decision Process

Category Variable Description

Financial

Profitability ROAINVYD

Net income ÷ AssetsTwo-year investment yield average based on cash + invested assets (IRIS6)a

UnderwritingPerformance

LRCR

Loss ratio (Losses & LAE incurred ÷ Premiums earned) Combined ratio

Liquidity LQASTAGBAL

Liabilities ÷ Liquid assets (IRIS8)Agents’ balance to surplus (IRIS9)

Capital Adequacy

NPWSURBCARb

Net premiums written ÷ Surplus (IRIS2)Best’s Capital Adequacy ratio

Capital Ln(Asset)SURPLUS

Log of total assetsPolicyholders’ surplus

Managerial

CONCENTb

DISTRIb

OWNER

Line concentration (a Herfindale index)Agency vs. direct vs. mixed marketing channelsDummy (stock vs. mutual ownership)

Political COMM Dummy (appointed vs. elected commissioner)

77

Empirical estimationEmpirical estimation

DataLiquidated, merged and acquired firm data from A.M. Best Database for 1999-2004

Financial data based on t-1 period from the year of exit

2,200 U.S. property-liability insurance firms

88

Parameter Estimates Parameter Estimates

Normal firm as baseA rise in (net premium written to surplus) more related to voluntary liquidation rather than staying in business

Similar relationship for profitability, underwriting performance and liquidity, but the actual impact is negligent

Getting large firms in terms of In(Asset) likely to stay in the market rather than to consider voluntary liquidation

Little difference in behavior between normal firms and merged/acquired firms

Between normal and involuntarily liquidated insurers, a rise in profitability or capital adequacy likely to cause them to consider involuntary liquidation rather than staying in the market

X Parameter Estimate Std. Error Wald Proba eβ b

1. VL Intercept - 2.658 1.150 5.344 0,021 *

ROA 0.118 0.067 3.099 0.078 * 1.125

LR 0.001 0.001 3.705 0.054 * 1.001

LQAST 0.002 0.001 4.134 0.042 * 1.002

NPWSUR 0.005 0.001 65.511 0.000 ** 1.005

Ln(Asset) - 0.304 0.099 9.326 0.002 ** 0.738

COMM - 0.158 0.362 0.191 0.662 0.854

OWNER 0.751 0.512 2.152 0.142 2.120

2. M&A Intercept - 4.053 1.544 6.888 0.009 *

ROA - 0.208 0.138 2.248 0.134 0.813

LR - 0.001 0.003 0.178 0.673 0.999

LQAST - 0.006 0.008 0.533 0.466 0.994

NPWSUR 0.010 0.006 3.182 0.074 * 0.990

Ln(Asset) 0.220 0.138 2.550 0.110 1.246

COMM - 0.851 0.519 2.686 0.101 * 0.427

OWNER - 0.753 0.563 1.784 0.182 0.471

3. INV Intercept 2.354 1.539 2.341 0.126

ROA 0.141 0.069 4.209 0.040 * 1.151

LR - 0.10 0.004 5.878 0.015 * 0.990

LQAST - 0.002 0.004 0.318 0.573 0.998

NPWSUR 0.004 0.001 8.445 0.004 ** 1.004

Ln(Asset) - 0.849 0.160 28.120 0.000 ** 0.428

COMM 0.832 0.621 1.797 0.180 2.298

OWNER 0.653 0.572 1.301 0.254 1.921

1010

Parameter EstimatesParameter EstimatesM&A firm as base

[Voluntary – M&A] An increase in size(Ln(Asset)) leads a merger/acquisition deal. Capital adequacy (NPWSUR) also very significant.

[Involuntary – M&A] A rise in ROA, NPWSUR and COMM lead to involuntary liquidation.

However, An increase in Ln(Asset), the most significant variable, leads to M&A rather than involuntary liquidation.

1111

Parameter EstimatesParameter EstimatesInvoluntary liquidated firm as base

Larger insurers—probably with a stronger wealth motive—more likely to respond to signals indicating financial or operational difficulty before they are captured by the regulator

[Voluntary – Involuntary ] A rise in ROA, NPWSUR and OWNER lead to the involuntary exits rather than voluntary exits.

1212

To be RefinedTo be Refined

Separation of healthy M&As from regulator-led M&As

Expansion of the time period, which is currently t-1

Further empirical exploration when a firm is considering all choices concurrently

Further study on interpretation of empirical results (e.g., profitability )

1313

Thank You!Thank You!