A study of agency cost effects on insurance company involvement in litigation

Claims payment is the primary service purchased by the majority of insurance buyers. It is the process through which people suffering loss interact with insurers that can create lasting consumer impressions of the industry. It is also the process that composes the majority of insurer costs and therefore must be carefully undertaken so as to provide timely, fair, and efficient claims service to maintain both policyholder satisfaction and financial stability. Despite its importance, very little is known about the claims function and about claims management patterns across insurers. The purpose of this research is to investigate the claims process as it relates to various insurer financial and organizational characteristics through analysis of federal litigation over insurance contract disputes. The results offer insight into the factors influencing insurer claims practices thereby providing useful information for policyholders interested in conditions that might influence the administration of their claims, for insurers desiring additional information about the effects of financial and organizational qualities on their claims strategies, and for state insurance regulators responsible for monitoring insurance company behavior.; In this study, agency cost theory and more specifically the managerial discretion hypothesis is used as a foundation for determining firm-level characteristics that influence insurance company actions with respect to policyholder litigation. Two hypotheses are tested. First, insurers experiencing lower levels of agency costs participate in claims management practices involving more managerial discretion. The second hypothesis is that those same low-agency cost insurers initiate litigation more frequently than insurers with higher agency cost levels. In the process of testing these hypotheses, interesting insights are also developed in terms of the level of discretion afforded insurance company management in cases resolved by trials relative to those ultimately settled.; The results of this research suggest that insurers experiencing higher levels of agency costs as a result of either ownership structure or extent of leverage tend to resolve more litigated cases through trials as opposed to settling them. Consistent with this, there is marginal evidence that stock insurers are less likely to experience adverse trial judgments compared to mutual insurers, presumably because stock insurers are more likely than mutuals to settle litigation. There was also empirical support for the second hypothesis that insurers with lower agency cost levels initiate litigation against their policyholders more frequently than do high-agency cost insurers, but only with respect to firm size.