Access to capital and the role of group affiliation in the insurance industry: Empirical evidence

This dissertation concerns itself with several closely related objectives. The first is to investigate the factors that explain the substantial increase in usage of subordinated debt contracts called surplus notes. The second is to examine more fully the role that group affiliation plays in determining capital retention levels and management of capital.; Chapter Three is devoted to the investigation of the determinants of surplus note utilization. Also known as surplus debentures or certificates of contribution, surplus notes are used by both life and property-liability insurance companies. Surplus notes are treated as non-admitted liabilities under statutory accounting principles, and this treatment makes them useful financing tools to raise regulatory capital. The results in Chapter Three showed that mutual insurers (life and property-liability), insurers that are group members (life), insurers with higher default risk (life and property-liability), and insurers with lower levels of regulatory capital (life and property-liability) were more likely to use surplus notes. The relation between the advent of risk-based capital standards and surplus note usage is one of the more important findings of this chapter.; Chapter Four focuses on three closely related issues that are addressed through the examination of the relation between group affiliation and the level and management of regulatory capital. The first deals with the group's response when faced with a member firms in financial distress. The second deals with whether group affiliation impacts on the level of regulatory capital retained by the firm. The third deals with the impact of the stringency of the regulatory environment on regulatory capital levels. The findings of this chapter show that intra-group capital transfers occur to financially distressed firms at the highest levels of regulatory scrutiny. This may indicate that indirect bankruptcy costs to the group exceeded the benefits of limited liability. It was also shown that insurers that are members of insurance groups tend to carry lower levels of regulatory capital. This benefit of intra-group capital management may help explain the increase in insurance groups. It was also shown that a more stringent regulatory environment results in higher capital retention by insurers.