Effects of Corporate Diversification: Evidence From the Property-Liability Insurance Industry

• Published in: The Journal of risk and insurance 2008-12, Vol.75 (4), p.893-919
• Main Authors: Liebenberg, Andre P., Sommer, David W.
• Format: Article
• Language: English
• Subjects: Accounting; Analysis; Automobile insurance; Business structures; Capital assets; Costs; Data envelopment analysis; Discounts; Diversification; Efficiency; Employee insurance; Hypotheses; Industrial sectors; Insurance companies; Insurance industry; Insurance premiums; Insurance providers; Liability insurance; Life insurance; Management; Market strategy; Portfolio diversification; Product diversification; Product lines; Property and casualty insurance; Property liability insurance; Rate of return; Rates of return; Return on assets; Stock exchanges; Stockholders; Studies
• ISSN: 0022-4367; 1539-6975
• DOI: 10.1111/j.1539-6975.2008.00290.x

Using a sample of property-liability insurers over the period 1995-2004, we develop and test a model that explains performance as a function of line-of-business diversification and other correlates. Our results indicate that undiversified insurers consistently outperform diversified insurers. In terms of accounting performance, we find a diversification penalty of at least 1 percent of return on assets or 2 percent of return on equity. These findings are robust to corrections for potential endogeneity bias, alternative risk measures, alternative diversification measures, and an alternative estimation technique. Using a market-based performance measure (Tobin's Q) we find that the market applies a significant discount to diversified insurers. The existence of a diversification penalty (and diversification discount) provides strong support for the strategic focus hypothesis. We also find that insurance groups underperform unaffiliated insurers and that stock insurers outperform mutuals.