Risk-adjusted efficiency of the insurance industry: evidence from China

Abstract

In order to investigate the interrelationship between risk and efficiency, based on the multistage data envelopment analysis (DEA) model, this paper introduces a modified measure of risk-adjusted efficiency for the insurance industry in China from 1999 to 2006. By comparing the results from the traditional DEA model and multistage DEA model, it is evident that there are significant changes in the firms' efficiency scores and their related ranks. The results show that the efficiency scores of the insurance firms studied tend to be underestimated if the endogenous risk factors due to bad management are not considered. With the continued development of the insurance industry in China, the insurance firms' capacity to manage risk has shown to have a significant positive impact on the improvement of their efficiency. Further, the risk-adjusted efficiency advantage of non-state-owned enterprises over state-owned enterprises is not as significant as it is when using the unadjusted models. However, the efficiency gap between foreign and domestic insurance firms shows an increasing trend during the sample period.

Keywords:

• risk-adjusted efficiency
• insurance industry
• data envelopment analysis

Acknowledgements

This research was supported by the National Natural Science Foundation of China (No. 70803036) and Program for Innovative Research Team and 211 Program in UIBE. We wish to thank the editors of SIJ, anonymous referees and the 2009 International Conference on Management Science & Engineering for their constructive comments and suggestions.

Notes

According the WTO agreements, China Insurance Regulatory Committee has publicized the specific opening commitment in insurance industry. Now, the foreign property insurance companies have been authorized to establish branch companies or joint-venture companies with a 51% proportion of foreign funds at most and could construct foreign-funded subsidiary companies in 2 years since its entrance. The foreign life insurance companies have been authorized to establish joint-venture companies with a no more than 50% proportion of foreign funds, which could choose freely joint-venture partners.

In particular, a γ-value of zero indicates that the deviations from the frontier are due entirely to noise, while a value of one would indicate that all deviations are due to inefficiency. If it does not reject the null hypothesis γ = 0 against the alternative that it is positive, then the deviations from the frontier are better represented as fixed effects in the function.

If Ψ _j  = 1, it indicates that there is no endogenous risk caused by bad management, and all risks are exogenous and due to unfavorable environment and random error, which means the risks are out of the firms' control and should be excluded in efficiency estimation. Conversely, if Ψ _j  = 0, all the risks would be due to internal factors and the jth DMU would be most inefficient in risk management.

In theory, the value of input slack is bigger, the distance with the efficiency frontier is farther and the efficiency score is lower. So, if the environmental variables have a significantly negative relationship with the slack of risk input, it indicates that external environmental factors can reduce the waste on the risk input of sample institutions. And it can be attributed to advantageous external factors, which has a significantly positive effect on the efficiency of risk management. The opposite is true.

This paper defines the SOEs as those insurers whose state and SOEs ownership is greater than 50% of total ownership.

The return on investment of China's insurance industry was only 3.97% on average over the period of 1999–2001.

At the end of 2007, Stocks, securities investment funds and other equities have accounted for about 15.4% of total invested assets and the return on investment reached to 12.17%.