Seminar by Ajay Subramanian

Please Note: This seminar will be given in-person.

Insurer Capital and Organizational Forms in Market Equilibrium

We develop a market equilibrium model to explain the coexistence and evolution of insurer capital structures and organizational forms as well as their cross-sectional variation across different insurance lines. Equity capital lowers insurer default risk, thereby increasing the demand for insurance and its price, but has associated frictional costs stemming from sources such as taxes, agency costs and intermediation fees.

Insurer capital structures and organizational forms reflect the tradeoff between the benefits and costs of equity, while also incorporating the impact of insurer administrative costs on insurance supply. We characterize the equilibrium and derive novel implications for insurer capital and organizational forms. Consistent with evidence, more (less) efficient insurers with lower (higher) administrative and capital raising costs are larger (smaller) and are more likely to be stock (mutual) insurers. Aggregate shocks to insurer assets and liabilities have non-monotonic effects that depend crucially on insuree loss sizes. When insuree loss claims are below a threshold, the degree of mutualization declines with aggregate asset and liability risks. When the loss size exceeds the threshold, however, mutualization increases with aggregate risks. Hence, insurance markets are dominated by mutual insurers when insuree loss claims and aggregate risks are either both low or both high. The results are consistent with evidence of an increase in mutualization following spikes in aggregate uncertainties associated with recessions as well as an increase in forecasts of insurance losses following catastrophes. Our predictions also potentially reconcile conflicting empirical evidence on the impact of aggregate loss shocks on mutualization. Decreases in the corporate tax rate or improvements in corporate governance lower the frictional costs of equity capital and, thereby, increase the prevalence of stock insurers.