Restructuring of the Dutch Nonlife Insurance Industry: Consolidation, Organizational Form, and Focus

ABSTRACT Since the deregulation of the European insurance market in 1994, Dutch nonlife insurance firms have sized up and increased their focus. Concurrently, the stock organizational form has become increasingly dominant. This article investigates these 1995-2005 trends from a cost-efficiency perspective. We observe substantial economies of scale that are even larger for smaller firms. In line with the efficient structure hypothesis, both stocks and mutuals are found to have comparative cost advantages. Supporting the strategic focus hypothesis, we find that more specialized insurers have lower costs. Thick frontier efficiency estimates point to large cost X-inefficiencies that have moderately decreased over time. INTRODUCTION During the past few decades, the financial services industry in Europe has changed dramatically, due in part to the European Union's (EU) financial services deregulation. In 1994, the Third Generation Insurance Directive (TGID) deregulated the European insurance market significantly. Since then, European insurance firms have been allowed to operate across national boundaries to encourage foreign competition. They are now also free to develop new products and to set prices at their discretion. The principal goal of deregulation in general and the EU's Single Market Program in particular is to improve market efficiency and enhance consumer choice through increased competition. (1) In formerly highly regulated European countries, deregulation meant a distinct break with the past. A prime example is Germany, where prices used to be regulated for the entire industry, enabling the most inefficient providers to remain in the market. (2) By contrast, in traditionally more liberal countries, like the Netherlands and the United Kingdom, the regime change had limited direct impact. The TGID transmitted a regulatory model similar to that of the Netherlands across Europe, fostering a level playing field, except where solvency regulation was concerned. Even so, the structure of the Dutch insurance industry has changed considerably in recent years. Between 1995 and 2005, the number of firms dropped by more than 20 percent, and average firm size increased by almost 100 percent in real terms. Interestingly, this market consolidation did not lead to widespread conglomeration of the industry. On the contrary, the market share of focused Dutch nonlife insurers--monolines active in one line of business only--actually increased during these years. At the same time, though relatively few demutualizations (i.e., mutual firms converting to stock charter) occurred, the market share of mutuals dropped substantially. This article investigates the restructuring of the Dutch nonlife insurance industry from a cost-efficiency point of view. The objective of the TGID suggests that efficiency considerations played a pivotal role in restructuring. Consolidation can improve the X-efficiency of an industry if it entails X-inefficient firms leaving the market, either via withdrawals or via mergers and acquisitions. In a consolidating market environment, X-efficiency may also improve because incumbent managers perceive the threat of a hostile takeover as higher, encouraging them to increase their effort and take up internal slack. Obviously, consolidation also has the potential to enhance scale efficiency when firms operate under increasing returns to scale. Organizational form is hypothesized to affect cost-efficiency mainly via comparative advantages of stocks and mutuals in dealing with agency costs. While the stock ownership form is more appropriate in controlling owner-manager conflicts, mutual ownership helps mitigate conflicts between owners and policyholders. Besides differences in dealing with agency problems, stocks have an advantage in their superior access to capital. The efficient structure hypothesis predicts that mutuals and stocks are sorted into market segments where their respective comparative advantages materialize. …