Abstract
We examine the existence of cost stickiness in the German property-liability insurance sector by analyzing if the percentage increase in administrative costs for a rise in premiums is larger than the percentage decrease in administrative costs for an equivalent drop in premiums. In addition, we analyze if sticky cost behavior depends on insurance firms’ organizational form. Using company-level data from German property-liability insurance firms for the years 2001–2017 and regression analyses, we find that administrative costs are sticky in the insurance sector, as administrative costs increase on average 0.82% per 1% increase in premiums but decrease only 0.6% per 1% decrease in premium income. Moreover, we find that stock insurers exhibit lower levels of cost stickiness, indicating better monitoring mechanisms.
Highlights
The current market environment emphasizes the importance of cost management in the insurance sector
Our results indicate that administrative costs are sticky in the German insurance industry: We show that administrative costs increase on average 0.82% per 1% increase in premiums but decrease only 0.6% per 1% decrease in premium income
Our results indicate that cost stickiness is more pronounced in mutual insurance firms, consistent with theory that predicts that mutual insurance firms have weaker control mechanisms than stock insurers and lower means to reduce agency problems within their organizations
Summary
The current market environment emphasizes the importance of cost management in the insurance sector. To ensure sufficient funds for current challenges, cost management is an essential determinant of success in the insurance sector. This holds for cost cutting measures in volatile times, that is, if activity levels decrease, costs should decrease in order to maintain profitability. Previous research from other industries shows that the decrease in costs is smaller for decreasing than the increase in costs for increasing activity levels for a given amount of change (Anderson et al 2003; Guenther et al 2014). The behavior of costs for differing levels of activity has to be closely analyzed, as non-consideration of cost stickiness deteriorates planning and may lead to suboptimal decisions (Anderson et al 2003)
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