Efficiency in the property-liability insurance industry

Abstract

The purpose of this study is to examine the cost impact resulting from P/L insurer inefficiency. A generalized Leontief profit function which allows for allocative and scale efficiency is estimated for 100 of the largest P/L insurers over the period 1980 through 1984. Excessive costs from nonoptimal use of resources are estimated by type of inefficiency. The dollar impact of this is estimated also. Estimated inefficiency costs are 12 to 33 percent of premiums. Problems in the property-liability (P/L) insurance industry have attracted considerable attention in recent years. Price and availability crises in markets such as auto and general liability insurance have occurred, and cost pressures have continued to build as insurers compete with risk retention alternatives. Rate regulation in some states has further exacerbated these problems. Although labor saving, computer related technological changes (such as automated report writing) are available, the white collar workforce of insurers has continued to grow. Issues such as these are important not only because the P/L insurance industry is important, but because cost pressures and increasing competition exist for the growing service sector. Premium levels have captured most of the public attention. Premiums (augmented by investment income) are designed to pay covered losses as well as insurers' administrative and underwriting expenses. Losses are the largest component of premiums. In 1988, premiums written in the P/L insurance industry was $202 billion, and incurred losses equaled $160 billion (Best's Aggregates and Averages, 1989). To deal with the large loss level in general liability some states have enacted tort reform which caps the maximum amount of noneconomic loss. Interest in no-fault auto insurance with a stringent threshold has resurfaced as a potentially more efficient compensation method and strategy to lower loss costs in automobile liability insurance.