Cost efficiency and scale economies in the Turkish insurance industry

Abstract

This article examines the cost efficiency and scale economies of insurance firms in the Turkish insurance industry over a 15-year period, 1990–2004. Using the stochastic cost frontier model, cost efficiency scores and scale economies were estimated for each firm in the sample. The results show that mean cost inefficiencies range between 18.3 and 36.9% of total costs and they do not tend to decrease over time. On average, small firms are more cost efficient than large firms. Economies of scale appear present and significant for any class size. The results suggest that there is a substantial difference in scale economies between small and large insurance firms.

Notes

¹ Cost efficiency consists of both allocative efficiency, which reflects the ability of the insurance firm to use the inputs in optimal proportions, given their respective prices, and technical efficiency, which reflects the ability of the firm to obtain maximum output from a given set of inputs.

² We exclude factor share equations, which embody restrictions imposed by Shephard's Lemma or Hotelling's Lemma, because these would impose the undesirable assumption of no allocative inefficiencies (Bauer, 1990; Cebenoyan et al., 1993; Berger and Mester, 1997).

³ The pooled model can only be used to measure inefficiency scores if the estimates of parameters have remained stable during the sample period. To examine whether parameters are stable, the sample divided into three sub-periods; 1990–1994, 1995–1999 and 2000–2004. The model was estimated for each period separately. The stability tests (Chow) were then performed to test for parameter stability between each pair of years. The results of tests suggest that all of the stability hypothesis were rejected at conventional significance level. The results are not reported but they are available from authors upon request.

⁴ Several studies that examine cost inefficiency of insurance industry for various countries also provide evidence that insurance firms in these industries operate inefficiently (Gardner and Grace, 1993; Hardwick, 1997; Cummins and Zi, 1998; Hao and Chou, 2005; Tone and Sahoo, 2005).

⁵ We classified the insurance firms as foreign if the share of foreign capital exceeded 50% in total capital formation.