A Comparison of DEA and SFA Approaches: Application to the US Non-Life Insurance Market

  • Sara Suárez-Fernández Faculty of Economics and Business, University of Oviedo, Spain
  • Raquel Quiroga-Garcia Faculty of Economics and Business, University of Oviedo, Spain
  • Isabel Manzano-Perez Faculty of Economics and Business, University of Oviedo, Spain
Keywords: DEA, Window DEA, SFA, insurance market, efficiency

Abstract

Analyzing the efficiency of markets is essential for both business managers and policymakers. On the one hand, private companies need to be as efficient as possible, given that their competitiveness and their chance of survival depend on it. On the other hand, public businesses claim to be committed to investing public funds in the best way. To be competitive, firms need to improve their performance by incorporating the benchmark practices of their field in their management, and studying efficiency levels may help identify potential areas for development. However, does the efficiency score depend on the method chosen to calculate it? In this paper, our aim is to compare the rate of agreement between two different approaches to measure efficiency, the parametric and the non-parametric. For the parametric procedure, we use stochastic frontier analysis (SFA), while in the case of the non-parametric, we use data envelopment analysis (DEA) and the dynamic approach of the DEA, the window DEA. To do so, we analyze 923 non-life (property/casualty) US insurance companies in the period 2007–2011. According to our results, comparable efficiency scores are found using SFA and DEA methodologies. More importantly, the two approaches rank companies in a similar order, mostly agreeing on which are the most and the least efficient firms. Therefore, we support that the approaches can be used complementarily.

References

Aigner, D. J., Lovell, C. A. K., & Schmidt, P. (1977). Formulation and estimation of stochastic frontier production function models. Journal of Econometrics, 6(1), 21–37.

Alhassan, A. L., & Biekpe, N. (2016). Competition and efficiency in the non-life insurance market in South Africa. Journal of Economic Studies, 43(6), 882-909.

Arrow, K. (1971). Essays in the theory of risk bearing. Chicago: Markham Publishing Company.

Asmild, M., Paradi, J.C., Aggarwall, V., & Schaffnit, C. (2004). Combining DEA window analysis with the Malmquist index approach in a study of the Canadian banking industry. Journal of Productivity Analysis, 21, 67-89.

Badunenko, O., Grechanyuk, B., & Talavera, O. (2006). Development under regulation. The way of the Ukrainian insurance market (Discussion Papers of DIW Berlin 644). Berlin: German Institute for Economic Research.

Banker, R. D., Charnes, A., & Cooper, W. W. (1984). Some models for estimating technical and scale inefficiencies in data envelopment analysis. Management Science, 30(9), 1078-1092

Battese, G. E., & Coelli, T. J. (1992). Frontier production functions, technical efficiency and panel data. With application to paddy farmers in India. Journal of Productivity Analysis, 3, 153–169.

Battese, G. E., & Coelli, T. J. (1995). A model for technical inefficiency effects in a stochastic frontier production function for panel data. Empirical Economics, 20, 325–332.

Bhisma, R. G., & Venkateswarlu, R. (2014). Efficiency of Indian private non-life insurance firms using stochastic frontier analysis. Journal of Economics and Finance, 4(1), 42-46

Biener, C., Eling, M., & Wirfs, J. H. (2016). The determinants of efficiency and productivity in the Swiss insurance industry. European Journal of Operational Research, 248(2), 703-714.

Borger De, B., & Kerstens, K. (1996). Cost efficiency of Belgian local governments. a comparative analysis of FDH, DEA, and econometric approaches. Regional Science and Urban Economics, 26(2), 145–170.

Brockett, P. L., Cooper, W. L., Golden, L. L., Rousseau, J. J., & Wang, Y. (2005). Financial intermediary versus production approach to efficiency of marketing distribution systems and organizational structure of insurance companies. The Journal of Risk and Insurance, 72(3), 393-412.

Charnes, A., Cooper, W. W., & Rhodes, E., (1978). Measuring the efficiency of decision making units. European Journal of Operational Research, 2(6), 429-444.

Charnes, A., Clark, C.T., Cooper, W.W., & Golany, B.A. (1985). A developmental study of data envelopment analysis in measuring the efficiency of maintenance units in the U.S. Air Forces. Annals of Operation Research 2(1), 95-112.

Charnes, A., & Cooper, W.W. (1985). Preface to topics in data envelopment analysis. Annals of Operation Research, 2, 59-94.

Cullinane, K., Song, D., Ji, P., & Wang, T. (2004). An application of DEA windows analysis to container port production efficiency. Review of Network Economics, 3(2), 184-206.

Cummins, J. D., & Nini, G. P. (2002). Optimal capital utilization by financial firms. Evidence from the property-liability insurance industry. Journal of Financial Services Research, 21(1-2), 15-53

Cummins, J. D., & Rubio-Misas, M. (2006). Deregulation, consolidation, and efficiency. Evidence from the Spanish insurance industry. Journal of Money, Credit and Banking, 38(2), 323-355

Cummins, J. D., Tennyson, S., & Weiss, M. A. (1999). Consolidation and efficiency in the US life insurance industry. Journal of Banking and Finance, 23, 325-357.

Cummins, J. D., & Weiss, M. A. (2000). Analyzing firm performance in the insurance industry using frontier efficiency and productivity methods, In G. Dionne (Ed.), Handbook of Insurance (pp 767-829). Dordrecht: Springer.

Cummins, J. D., & Xie, X. (2008). Mergers and acquisitions in the US property-liability insurance industry. Productivity and efficiency effects. Journal of Banking and Finance, 32, 30-55.

Cummins, J. D. & Xie, X. (2013). Efficiency, productivity and scale economics in the U.S. property–liability insurance industry. Journal of Productivity Analysis, 39, 141-164.

Cummins, J.D. & Zi, H. (1998). Comparison of frontier efficiency methods: An application to the US life insurance industry. Journal of Productivity Analysis, 10(2), 131-152.

Diacon, S.R., Starkey, K., & O`Brien, C. (2002). Size and efficiency in European long-term insurance companies. An international comparison. The Geneva Papers on Risk and Insurance, 27(3), 444-466.

Dong, Y., Hamilton, R., & Tippet, M. (2014). Cost efficiency of the Chinese banking sector. A comparison of stochastic frontier analysis and data envelopment analysis. Economic Modelling, 20, 298-308

Eling, M., & Luhnen, M. (2010a). Frontier efficiency methodologies to measure performance in the insurance industry. Overview, systematization and recent developments. Geneva Papers on Risk and Insurance, 35(2), 217-1265.

Eling, M. & Luhnen, M. (2010b). Efficiency in the international insurance industry. A cross-country comparison. Journal of Banking and Finance, 34(7), 1497-1509.

Eling, M. & Jia, R. (2019). Efficiency and profitability in the global insurance industry. Pacific-Basin Finance Journal, 57, 101190.

Ennsfellner, K.C., Lewis, D., & Anderson, R. I. (2004). Production efficiency in the Austrian insurance industry. A Bayesian examination. The Journal of Risk and Insurance, 71(1), 135-159.

Ertugrul, I., Oztas, G. Z., Ozcil, A., & Oztas, T. (2016). Efficiency analysis of non-life insurance companies in terms of underwritting process with Data Envelopment Analysis. European Scientific Journal, Special Edition.

Farrel, M.J. (1957). The measurement of productive efficiency. Journal of Royal Statistical Society, Series A, 120, Part III, 253-290.

Ferro, G., & León, S. (2017). A Stochastic frontier analysis of efficiency in Argentina’s non-life insurance market, The Geneva Papers on Risk and Insurance. 43(1), 158-174.

Halkos, G. E., & Tzeremes, N. G. (2009). Exploring the existence of Kuznets curve in countries’ environmental efficiency using DEA window analysis, Ecological economics. 68, 2168-2176.

Hemmasi, A., Talaeipour, M., Khademi-Eslam, H., Farzipoor, S. R.& Pourmousa, S. H. (2011). Using DEA window analysis for performance evaluation of Iranian wood panels industry. African Journal of Agricultural Research, 6(7), 1802-1806.

Jaloudi, M.M. (2019). The efficiency of Jordan insurance companies and its determinants using DEA, slacks, and logit models. Journal of Asian Business and Economic Studies, 26(1), 153-166.

Jarraya, B. & Bouri, A. (2013). Efficiency concept and investigation in insurance industry. A survey. Management Science Letters, 3, 39-54

Jia, T., & Yuan, H. (2017). The application of DEA (Data Envelopment Analysis) window analysis in the assessment of influence on operational efficiencies after the establishment of branched hospitals. BMC Health Services Research, 17, 265.

Gaganis, C., Hasan, I., & Pasiouras, F. (2013). Efficiency and stocks return. Evidence from the insurance industry. Journal of Productivity Analysis, 40, 429-442.

Kaffasha, S., Azizi, R., Huangc, Y., Zhu, J. (2020). A survey of data envelopment analysis applications in the insurance industry 1993–2018. European Journal of Operational Research, 284(3), 801-813.

Klumpes, P. (2005). Managerial use of discounted cash-flow or accounting performance measures. Geneva Papers on Risk and Insurance, 30(1), 171-186.

Knezevic, S., Markovic, M., & Brown, A. (2015). Measuring the efficiency of Serbian insurance companies. Acta Oeconomica, 65(1), 91-105.

Kumbhakar, S. C., & Lovell, C. A. K. (2000). Stochastic Frontier Analysis. Cambridge: Cambridge University Press.

Leverty, J. T., & Grace, M. F. (2008). Issues in measuring the efficiency of property-liability insurers. Paper presented at the Risk Management Laboratory - Uses of Frontier Efficiency Methodologies for Performance Measurement in the Financial Services Sector, Imperial College Business School, London.

Meeusen, W., & Broeck, J. (1977). Efficiency estimation from Cobb-Douglas production functions with composed error. International Economic Review, 18(2), 435-44

Mose, V. O. (2013). Efficiency of non-life insurance business in Kenya: Stochastic frontier approach. Retrieved from https://ssrn.com/abstract=2262754

Nawi, M. A. A., Ahmad, W. M. A.W, & Alenge, N. A. (2012). Efficiency of general insurance in Malaysia using stochastic frontier analysis. International Journal of Modern Engineering Research, 2(5), 3886-3890.

Singh, A., & Zahran, Z. (2013). A comparison of efficiency of Islamic and conventional insurers (Towers Watson Technical Paper No. 2100531). Retrieved from https://ssrn.com/abstract=2306013

Wise, W. (2017). A survey of life insurance efficiency papers. Methods, pros & cons, trends. Accounting, 3(3), 137–170.

Yaisawarng, S., Asavadachanukorn, P., & Yaisawarng, S. (2014). Efficiency and productivity in the Thai non-life insurance industry. Journal of Productivity Analysis, 41, 291-306.

Yang, H., & Chang, C. (2009). Using DEA window analysis to measure efficiencies of Taiwan’s integrated telecommunication firms. Telecommunications Policy, 33, 98-108.

Zanghieri, P. (2009). Efficiency of European insurance companies. Do local factors matter? Retrieved from https.//ssrn.com/abstract=1354108

Zhang, X., Cheng, X., Yuan, J. & Gao, X. (2011). Total-factor energy efficiency in developing countries. Energy Policy, 39, 644-650.

Published
2021-07-31
How to Cite
Suárez-Fernández, S., Quiroga-Garcia, R., & Manzano-Perez, I. (2021). A Comparison of DEA and SFA Approaches: Application to the US Non-Life Insurance Market. Applied Economics Journal, 28(2), 107-127. Retrieved from https://so01.tci-thaijo.org/index.php/AEJ/article/view/242756
Section
Research Articles