An empirical investigation of market structure, efficiency, and performance in property-liability insurance

The financial services industry is in the midst of consolidation and restructuring worldwide. Financial service firm consolidation in the U.S. has accelerated because of technological progress and deregulation (e.g., the Gramm-Leach-Bliley Act of 1999). The recent movement toward consolidation within the insurance industry and across industry segments is affecting the structure of the insurance market. Consolidation impacts competition and the economic performance of the industry. Therefore, a public policy question arises as to the effect of consolidation on consumers and whether or not antitrust policy or other regulatory actions should be pursued by government. This research directly investigates these issues directly.; Little research has been conducted on the structure-performance relationship for the insurance industry, and the research that does exist contains conflicting results. Moreover, no existing insurance study explicitly incorporates the effects of efficiency on structure-performance. This paper tests the structure-performance relationship for the property-liability insurance industry using explicit measures of X-efficiency and scale efficiency. Both cost and revenue efficiencies are examined, and this is the first research to use revenue efficiency to explain market structure and performance. Four specific hypotheses are examined: structure-conduct-performance (SCP), relative market power (RMP), X-efficiency-structure hypothesis (ESX) and scale efficiency-structure hypothesis (ESS). Company data at the state level for the period 1992 to 1998 are used to investigate the four hypotheses.; The results support the efficiency-structure hypothesis and indicate that it is important to control for efficiency in examining structure and performance in this industry. Otherwise, spurious correlations among market structure, conduct, and performance may be observed. Both the SCP and RMP hypotheses are not supported when efficiency is controlled for. The implications of this research suggest that regulators should be more concerned with efficiency (both cost and revenue) rather than market power that may arise from consolidation. That is, cost X-efficiency is associated with lower prices and higher profitability for insurers. This study also shows that revenue X-efficiency is positively related to profit and price, indicating that consumers may derive less benefit from revenue X-efficiencies than insurers.