Organizational Structure, Board Composition, and Risk Taking in the U.S. Property Casualty Insurance Industry

We examine the incentive effects of CEO inside debt holdings (pensions and deferred compensation) on risk taking using the sample of U.S. publicly traded property–liability insurers. To represent managerial risk taking, we employ value at risk (VaR) and expected shortfall (ES), which capture extreme movements in the lower tail of insurer stock return distribution. We also estimate firm default risk, equity volatilities, and insurance‐related risk as alternative measures of risk taking. We document that inside debt represents a significant component of CEOs’ compensation in the insurance industry. We find that there is a significant and negative relationship between CEO inside debt holdings and risk‐taking behavior. The results suggest that the structure of executive debt‐like compensation could be a potential method of reducing managers’ risk‐taking incentives.

Section: Resultssupporting

confidence: 92%

Section: Resultsmentioning

confidence: 93%

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CEO Inside Debt and Risk Taking: Evidence From Property–Liability Insurance Firms

Milidonis¹,

Nishikawa²,

Shim³

2017

“…They find evidence that the aforementioned environmental factors decrease risk taking without impacting performance. With the exception of these two studies (Fields, Gupta, and Prakash, ; Eling and Marek, ), recent research on governance in the insurance industry has analyzed single‐country samples (see, e.g., Cole, He, and McCullough, ; Ho, Lai, and Lee, ).…”

Section: Background Literature and Hypothesis Developmentmentioning

confidence: 99%

RISK GOVERNANCEINTHE INSURANCE SECTOR—DETERMINANTSAND CONSEQUENCESINAN INTERNATIONAL SAMPLE

Magee¹,

Schilling²,

Sheedy³

2017

We analyze the relation between risk governance, risk, and performance measures for a global sample of 107 insurance companies from 2004 to 2012. Our risk governance index (RGI) covers several Solvency II provisions and includes the existence of chief risk officer on the executive committee, risk committee characteristics, and board industry experience. We find that in the crisis period 2008–2009, firms with a higher RGI generally have lower expected default frequency. We conclude that during noncrisis years, risk governance does not have a risk‐reducing effect but is positively associated with buy‐and‐hold returns, risk‐adjusted performance measures, and Tobin's Q. Our findings therefore support the role of risk governance as a business enabler rather than inhibitor. Insurance companies typically upgrade their risk governance following a negative shock, especially in countries that are well regulated and have weaker shareholder rights.

“…Managers of stock insurers have more incentives to increase asset risk because of compensation packages such as stock options. Ho, Lai, and Lee () find that mutual insurers have lower total, underwriting, and investment risks than stock insurers. We expect this variable to be positively related to the insurer's financial stability because mutual insurers are less likely to take excessive risks compared to stock companies.…”

Section: Hypotheses and Variable Estimationmentioning

confidence: 99%

AN INVESTIGATIONOF MARKET CONCENTRATIONAND FINANCIAL STABILITYIN PROPERTY–LIABILITY INSURANCE INDUSTRY

Shim¹

2015

The article investigates whether the market concentration is associated with an insurer's financial stability in the U.S. property–liability insurance industry over the period 1992–2010. We employ two‐stage least squares techniques with instrumental variables to address likely endogeneity problems. The results show that higher market concentration is associated with lower financial stability of insurance firms, consistent with the “concentration‐fragility” view. Our results indicate that firm‐specific characteristics including firm size, underwriting leverage, organizational form, product and geographical diversification, along with the exposure to natural catastrophes and macroeconomic conditions are important determinants in ensuring a safe and sound insurance system. Robustness tests using various estimation methods and alternative measures of financial stability present consistent results.