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

Frontier efficiency and productivity methodologies have become the state-of-the-art for measuring the performance of firms and other organizations. Traditional theory assumes that all firms minimize costs and maximize profits and that firms that do not succeed in attaining these objectives do not survive. The frontier approach reflects the recognition that some firms will be less successful than others in minimizing costs or maximizing profits and that such firms may be able to survive for some period of time. Modern efficiency methodologies measure firm performance relative to “best practice” cost, revenue, or profit frontiers consisting of the dominant firms in the industry. This chapter explains modern frontier methodologies, discusses input and output measurement for insurers, and reviews the most significant studies utilizing frontier methodologies to analyze the insurance industry. These studies not only measure efficiency but also identify firm characteristics that are associated with efficiency and analyze classic industrial organization topics such as economies of scale and scope. Efficiency and productivity measurement is useful in testing economic hypotheses, informing regulators about firm performance, providing information to management, and comparing performance across countries. It is hoped that this chapter will encourage more economists to use these methodologies in testing hypotheses and measuring performance in insurance and other industries.