The purpose of this paper is to provide new empirical evidence on frontier efficiency measurement in the international insurance industry, a topic of great interest in the academic literature during the last several years. A broad efficiency comparison of 6462 insurers from 36 countries is conducted. Different methodologies, countries, organizational forms, and company sizes are compared, considering life and non-life insurers. We find a steady technical and cost efficiency growth in international insurance markets from 2002 to 2006, with large differences across countries. Denmark and Japan have the highest average efficiency, whereas the Philippines is the least efficient. Regarding organizational form, the results are not consistent with the expense preference hypothesis, which claims that mutuals should be less efficient than stocks due to higher agency costs. Only minor variations are found when comparing different frontier efficiency methodologies (data envelopment analysis, stochastic frontier analysis).

Efficiency in the international insurance industry: A cross-country comparison

This chapter reviews the modern frontier efficiency and productivity methodologies that have been developed to analyze firm performance, emphasizing applications to the insurance industry. The focus is on the two most prominent methodologies—stochastic frontier analysis using econometrics and non-parametric frontier analysis using mathematical programming. The chapter considers the underlying theory of the methodologies as well as estimation techniques and the definition of inputs, outputs, and prices. Seventy-four insurance efficiency studies are identified from 1983 to 2011, and 37 chapters published in upper tier journals from 2000 to 2011 are reviewed in detail. Of the 74 total studies, 59.5% utilize data envelopment analysis as the primary methodology. There is growing consensus among researches on the definitions of inputs, outputs, and prices.

Analyzing Firm Performance in the Insurance Industry Using Frontier Efficiency and Productivity Methods

This paper investigates economies of scope in the US insurance industry over the period 1993-2006. We test the conglomeration hypothesis, which holds that firms can optimize by operating a diversity of businesses, versus the strategic focus hypothesis, which holds that firms can best add value by focusing on core competencies. We analyze whether it is advantageous for firms to diversify by offering both life-health and property-liability insurance or to specialize in one major industry segment. We estimate technical, cost, revenue, and profit efficiency utilizing data envelopment analysis (DEA) and test for scope economies by regressing efficiency scores on an indicator variable for strategic focus and control variables. Property-liability insurers realize cost scope economies, but they are more than offset by revenue scope diseconomies. Life-health insurers realize both cost and revenue scope diseconomies. Hence, strategic focus is superior to conglomeration in the insurance industry.

Economies of Scope in Financial Services: A DEA Efficiency Analysis of the US Insurance Industry

Prior studies show that enterprise risk management improves firm performance. This article investigates which aspects of enterprise risk management add value. We find that the use of economic capital models and dedicated risk managers improve operating performance. Requiring the dedicated risk manager report to the board of directors or to the chief executive officer (CEO) also increases value. The following combination of enterprise risk management initiatives yields the greatest increase in firm value: a simple economic capital model, a dedicated risk manager that is a cross-functional committee, and requiring the risk manager report to the board or CEO. Modigliani and Miller (1958) establish that in perfect capital markets capital structure does not affect the market value of the firm. Risk management also does not create value in perfect capital markets. In imperfect capital markets, however, researchers have posited that risk management may create value by reducing and / or exploiting market imperfections--taxes (Modigliani and Miller, 1963; Graham and Smith, 1999), bankruptcy costs (Kraus and Litzenberger, 1973; MacMinn, 1987), the cost of external capital (Froot, Scharfstein, and Stein, 1993), and agency costs (Jensen and Meckling, 1976; Myers, 1977; Mayers and Smith, 1982, 1987; MacMinn, 1987; Garven and MacMinn, 1993). The focus of these studies is largely on traditional risk management. The traditional approach to risk management is a silo technique in which one risk is managed at a time without acknowledging the interrelationship of risks. In contrast, enterprise risk management (ERM) is an enterprise-level assessment, quantification, financing, and managing of risk. It is a holistic approach to risk management. ERM emphasizes that the organizational benefits of risk management can also create value for firms (Nocco and Stulz, 2006). With ERM a firm examines risks jointly, assessing the interaction of each risk with the firm's portfolio of other important risks (Froot and Stein, 1998). (1) Beyond improving internal decision making (Nocco and Stulz, 2006), ERM can also lead to more efficient capital allocation (Myers and Read, 2001), better capital structure decisions (Graham and Rogers, 2002), and better risk management decisions (Mayers and Smith, 1982; Cummins, Phillips, and Smith, 2001). ERM can also advance risk awareness that improves operational and strategic decisions. Even though researchers have pointed to the strategic and operational value of using an enterprise risk approach (Doherty, 2000), the vast majority of empirical studies investigate whether the behavior of firms that use financial derivatives is consistent with extant theories about market imperfections (e.g., Allayannis and Weston, 2001; Kim, Mathur, and Nam, 2006). A handful of studies examine the value of ERM by investigating the appointment of a chief risk officer (CRO) (e.g., Hoyt and Liebenberg, 2003, 2011; Beasley, Pagach, and Warr, 2008; Pagach and Warr, 2011; Lin, Wen, and Yu, Forthcoming). Hoyt and Liebenberg (2011) find that ERM adds significant value to publicly traded insurers. They conclude that future research should identify the specific ways in which ERM contributes to firm value. This study seeks to do just that. Specifically, it identifies the components of an ERM program and investigates the impact of each on firm value. We do this by using a unique survey conducted by Tillinghast Towers Perrin. The objective of the survey was to evaluate the ERM practices of their worldwide insurance clients. We link this survey information to insurer annual statutory financial data to examine the impact of ERM initiatives on firm cost and revenue efficiency. We then calculate the annual costs savings and revenue enhancement of adopting various ERM initiatives and the associated impact on the average firm's return on assets (ROA). In sum, linking the survey information to insurer annual financial data allows us to investigate the cash flow implications of adopting various ERM initiatives for both public and private firms. …

The Value of Investing in Enterprise Risk Management

This paper investigates economies of scope in the US insurance industry over the period 1993–2006. We test the conglomeration hypothesis, which holds that firms can optimize by diversifying across businesses, versus the strategic focus hypothesis, which holds that firms optimize by focusing on core businesses. We analyze whether it is advantageous for insurers to offer both life-health and property-liability insurance or to specialize in one major industry segment. We estimate cost, revenue, and profit efficiency utilizing data envelopment analysis (DEA) and test for scope economies by regressing efficiency scores on control variables and an indicator for strategic focus. Property-liability insurers realize cost scope economies, but they are more than offset by revenue scope diseconomies. Life-health insurers realize both cost and revenue scope diseconomies. Hence, strategic focus is superior to conglomeration in the insurance industry.

Economies of scope in financial services: A DEA efficiency analysis of the US insurance industry.

The purpose of this paper is to provide an overview on frontier efficiency measurement in the insurance industry, a topic of great interest in the academic literature during the last several years. We provide a comprehensive survey of 95 studies with a special emphasis on innovations and recent developments. We review different econometric and mathematical programming approaches to efficiency measurement in insurance and discuss the choice of input and output factors. Furthermore, we categorise the 95 studies into 10 different areas of application and discuss selected results. While there is a broad consensus with regard to the choice of methodology and input factors, our review reveals large differences in output measurement. Significant need for future research can be identified, for example, with regard to analysis of organisational forms, market structure and risk management, especially in the international context.

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Frontier Efficiency Methodologies to Measure Performance in the Insurance Industry : Overview, Systematization, and Recent Developments

This paper provides a comprehensive analysis of efficiency and productivity in the German property-liability insurance industry, a market that has experienced significant change in recent years. Using data envelopment analysis (DEA) and covering the period 1995–2006, we find that there is potential for the market to improve by about 20 percentage points in terms of technical efficiency and about 50 percentage points in terms of cost efficiency. Furthermore, the analysis shows moderate total factor productivity growth and low efficiency growth during the sample period. A major contribution of the paper is its analysis of six efficiency determinants – firm size, distribution channels, ownership forms, product specialisation, financial leverage and premium growth – using a truncated regression and bootstrapping approach to avoid invalid inference.

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Determinants of Efficiency and Productivity in German Property-Liability Insurance: Evidence for 1995–2006

The purpose of this paper is to provide an overview and new empirical evidence on frontier efficiency measurement in the insurance industry, a topic of great interest in the academic literature during the last several years. In the first step, we review 87 studies and put them into a joint evaluation of efficiency measurement in the field of insurance. In the second step, a broad efficiency comparison of 3,555 insurers from 34 countries is conducted. Different methodologies, countries, organizational forms, and company sizes are compared, considering life and non-life insurers. We find a steady technical and cost efficiency growth in international insurance markets from 2002 to 2006, with large differences across countries. Denmark and Japan have the highest average efficiency, whereas the Philippines is the least efficient. Furthermore, the analysis shows that mutuals are more efficient than stock companies. Only minor variations are found when comparing different frontier efficiency methodologies (data envelopment analysis, stochastic frontier analysis). The results give valuable insights into the international competitiveness of insurers in various countries.

Frontier Efficiency Methodologies to Measure Performance in the Insurance Industry: Overview and New Empirical Evidence

This paper analyzes price competition in the German motor insurance market since 1994 and looks for evidence to back up a claim frequently found in the trade literature—that there have been two recent price wars in this industry, the first in 1996–1999, the second in 2005–2006. In a first step, we analyze the development of the German motor insurance market and compare it to that of other property-liability lines of business. In a second step the applicability of price war definitions found in the marketing literature to the German motor insurance market is checked. In a third step, a comparison to reference cases from other industries, where price wars have been subject to academic analysis, is conducted to complement the analysis. We conclude that, contrary to reports in the trade literature, the periods of 1996–1999 and 2005–2006 should be considered as times of intense competition in the motor insurance industry, not as times of price war.

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Michael Luhnen

Papers

Efficiency in the international insurance industry: A cross-country comparison

Frontier Efficiency Methodologies to Measure Performance in the Insurance Industry : Overview, Systematization, and Recent Developments

Determinants of Efficiency and Productivity in German Property-Liability Insurance: Evidence for 1995–2006

Frontier Efficiency Methodologies to Measure Performance in the Insurance Industry: Overview and New Empirical Evidence

Understanding price competition in the German motor insurance market