Diversification as a Process: Geographic Expansion and the Formation of National Insurers

Large financial intermediaries are more stable than small ones, and the largest are also the most geographically diversified. Whether that breadth is a source of stability or a byproduct of scale is difficult to establish, since intermediaries diversify by growing large. I examine how the diversified intermediary is assembled, using a newly digitized firm-by-state panel of the near-universe of U.S. life insurers from 1888 to 1940, the largest nonbank institutional investors of the period. Over these decades, the number of insurers per state more than quadrupled and within-state concentration declined by half, yet a small number of geographically extensive insurers retained a stable share of national premiums. I decompose firm-level outcomes into the insurer’s underwriting level and the composition of its book. Insurers entered new states before attaining scale, each entry constituting a small and favorably selected position with the convex payoff of a real option. The most successful decile of entries generated half of a cohort’s premium. Expansion was costly on two margins: a broad insurer earned less per dollar of coverage and paid 15.1 percent more in claims than an equally large insurer writing in the same state and year. The pricing cost is attributable to the composition of a broad insurer’s book, the claims cost to the insurer itself. A comparison across firms understates the claims cost, since the markets a broad insurer adds exhibit favorable claims experience of their own. Stability, by contrast, is attributable to scale, since breadth’s advantages in volatility and survival vanish conditional on size. Risk pooling was bounded: approximately nine tenths of an insurer’s loss-ratio variance was common to its markets. Diversification was the product of costly expansion, and the stability attributed to it is the scale that expansion produced.