Analysis of Cost Efficiency of Indian Life Insurers: A comparison of Quantity vs Value based DEA Approach

Abstract

Abstract In the context of measuring economic performance, efficiency and productivity of Indian life insurance firms, there are studies using the Data Envelopment Analysis (DEA) methodology. In this paper, the difference between the quantity based approach and value based approach is highlighted and elaborated using data of Indian life insurers operational over the period 2005–06 to 2015–16. There are both advantages and disadvantages of using DEA, as highlighted in the theoretical literature. In particular, the efficiency estimates are heavily influenced by the selection of inputs and outputs. This study provides an insight on technical efficiency and innovates in terms of data use and is the first study on the Indian insurance industry to compute cost and allocative efficiencies. Four hypotheses were tested in the study. First, there were initially improvements in efficiency but in recent years, clearly there is stagnation. Second, the results support views of Tone and Sahoo (2005) and Sen (2010), that the public life insurer, the Life Insurance Corporation of India is cost inefficient. The private life insurers need to reallocate resources to improve overall efficiency. LICI was found to be technically efficient but remained cost inefficient. Third, the traditional Farrell based cost efficiency estimates are significantly different from Tone (2002) alternative approach. Therefore, choice of estimation method is important. Fourth, non-discretionary factors such as age, premium growth and size of the insurers along with regulations pertaining to solvency affect cost efficiency. Key financial ratios such as expense ratio, commission ratio, conservation ratio and persistency ratio, and retention ratio are used to statistically establish their relationship with the different efficiency estimates. Results also show that entry of a new insurer may negatively affect cost efficiency of an existing insurer but foreign equity could positively improve cost efficiency.