Issues in Measuring the Efficiency of Property-Liability Insurers

• Main Author: Leverty, James Tyler
• Format: Others
• Published: Digital Archive @ GSU 2005
• Subjects: Frontier Efficiency Analysis; Data Envelopment Analysis; Property-Liability Insurance; Range Adjusted Measure; Insurance
• Online Access: http://digitalarchive.gsu.edu/rmi_diss/12; http://digitalarchive.gsu.edu/cgi/viewcontent.cgi?article=1011&context=rmi_diss

To date there is little evidence on the relationship between property-liability (P/L) insurer’s frontier efficiency measures and the market. The establishment of a connection is important since there are a number of difficulties associated with measuring P/L insurer efficiency—there is uncertainty regarding the firm’s primary objective, the main services produced, and the measurement of these services. The main goal of the dissertation is to assess the robustness of two approaches to measuring P/L insurer efficiency —the production approach (Cummins and Weiss, 2001) and the flow approach (Brockett, et al, 2004). A secondary objective is to evaluate the performance of two proxies for the production approach’s risk-bearing and “real” loss-services output to observe whether unexpected losses leads to a distortion of efficiency. A third purpose is to determine the sensitivity of the use of the policyholder supplied debt capital input in the production approach. A fourth aim is to evaluate the performance of the range adjusted measure (RAM) of efficiency compared to the traditional data envelopment analysis (DEA) method. A final objective is to assess the connection of accounting-based efficiency to market performance measures. The empirical evidence suggests that unexpected losses do not appear to overly distort the efficiency analysis. The production approach is not extraordinarily sensitive to the inclusion (or exclusion) of the policyholder supplied debt capital input. Traditional DEA measures of efficiency, in comparison to RAM, are more accurate predictors of insolvency and are more highly related to traditional measures of firm performance. Overall, the flow approach is not consistent with the production approach. Firms identified as highly efficient by the production approach are found to be significantly less likely to fail, indicating that the production approach is consistent with the economic reality of P/L insurance market. In contrast, high flow efficient firms are often found to have a higher proclivity to fail. Production approach efficiency is also more highly correlated to traditional measures of firm performance than flow measures of efficiency. The accounting-based production approach is directly related to market measures of firm performance, while flow efficiency is inversely related or unrelated to these measures.