Efficiency in the U.S. Life Insurance Industry: Are Insurers Minimizing Costs and Maximizing Revenues?

Abstract

Insurers are increasingly using benchmarking techniques to identify operations that need improvement by comparing their performance with other firms in the industry. An important new class of bench-marking methods has been developed called frontier efficiency methodologies. The frontier methodologies measure firm performance relative to “best practice” frontiers derived from firms in the industry. Such measures are superior to traditional techniques such as financial ratio analysis because they summarize firm performance in a single statistic that controls for differences among firms using a sophisticated multidimensional framework. Frontiers can be estimated to measure firm success in employing technology (technical efficiency), attaining optimal size (scale efficiency), minimizing costs (cost efficiency), maximizing revenues (revenue efficiency), and maximizing profits (profit efficiency). In this chapter, frontier efficiency analysis is employed to evaluate the efficiency of U.S. life insurance companies. We estimate technical, scale, cost, and revenue efficiency for a sample of insurers that represent 80 percent of industry assets.