The relations among organizational and distribution forms and capital and asset risk structures in the life insurance industry

This article is the first step toward integrating in a single framework two previously separate lines of research on major structural decisions of life insurers. The literature has previously studied the relation between capital structure and asset risk on the one hand, and the relation between organizational form and distribution system on the other hand, without integrating them. Using life insurer data for 1993-1999, we model the four key insurer decisions of capital structure, asset risk, organizational form, and distribulion system as endogenous choices in a single interrelated set of simultaneous equations. The model assesses the nature of the interactions among these decisions. The model also assesses the impact of insurers fundamental business strategy (treated as predetermined) on these choices. The business-strategy hypothesis views other key decisions as jointly determined and driven by the fundamental business strategy, once the latter is set in motion. Confirming previous studies, we find a positive relation between capital ratios and asset risk. We also find an association in the simultaneous context between stock ownership and brokerage distribution, which was not found in prior studies. Stock ownership is related to greater financial and asset risk taking, whereas brokerage distribution is associated with lower risk taking. These and other results are interpreted in light of several theories, including transaction-cost economics (TCE), agency theory, and regulatory and bankruptcy cost avoidance. Deriving from these theories, the finite risk paradigm emerges as the most comprehensive interpretation of the results, as opposed to the risk-subsidy hypothesis of the impact of guarantee funds. We also find support for the notion that the business strategy drives the capital and distribution decisions, as predicted by TCE.