Profitability and Efficiency in the U.S. Life Insurance Industry

This study explores the relationship between cost inefficiency and profitability in the U.S. life insurance industry. Earnings have particular importance to life insurance companies because earnings and capital determine the viability of the insurer. Since the life insurance industry is mature and highly competitive, cost efficiency may be the main driver of profitability. We derive cost efficiency using the stochastic frontier (SF) method allowing the mean inefficiency to vary with organizational form and the outputs. In addition, the estimation of the cost efficiency measure takes into account the underlying accounting concepts that generate the data and, consequently, the product mix (long-duration policies vs. short-duration policies) to avoid distorted estimates. Our results suggest that cost inefficiency in the life insurance industry is substantial relative to earnings, and that inefficiency is negatively associated with profitability measures such as the return on equity. The analysis of inefficiency and organizational form suggest that stock (shareholder-owned) companies are as efficient and profitable as mutual (policyholder-owned) companies.     

Comparisons of Economic Inefficiency Between Output and Input Measures of Technical Inefficiency Using the Fourier Flexible Cost Function

The current paper constructs a Fourier flexible cost function, which is commonly known to be a more general function form than the typical translog form, and can globally approximate a true (but unknown) cost function. Both allocative and technical inefficiencies are considered using the Fourier function in the context of the parametric approach. The former is modeled using shadow input prices and the latter is formulated either by adding an extra term of scale parameter (when the Farrell's (1957) input technical inefficiency is assumed), or by correcting all the terms involving output quantities by a scale parameter (when the Farrell's output technical inefficiency is assumed). It is found that sample banks could save up to 23% of total costs, within the range of 3 and 69% uncovered by the previous works, in which allocative inefficiency plays a more important role than technical inefficiency. Furthermore, the cost of misallocated labor input alone constitutes more than 80% of total allocative inefficiency. Financial deregulation starting from 1991 in Taiwan appears to have improved economic efficiency of the banking industry.     

Under pressure: community water systems in the United States—a production model with water quality and organization type effects

This paper examines the interaction of productive efficiency, water quality and organizational type. A water quality index is constructed employing various contaminants which are then treated together with variables including organizational type as endogenous in an input distance function model. The cost of drinking water quality and inefficiency are derived and hypothesis tests estimated concerning their variation by location, organization type and water quality. The key findings are that more technically efficient water utilities deliver higher quality drinking water and that private firms distribute higher quality water at a higher price and at a higher implicit cost than public utilities despite no overall inefficiency differences between the two organizational types.     

Beyond profitability: effects of acquisitions on technical efficiency in the Italian pasta industry

Unlike traditional studies on the impact of ownership changes—which use either profitability measures or stock prices—this paper investigates the impact of acquisitions on acquired firms' technical efficiency. Using a panel of Italian firms in the pasta industry for the 1981–1997 period, I estimate a stochastic production frontier with exogenous factors affecting efficiency in a translog specification with non‐neutral technical progress. The main result is that acquired firms experience, within the 6 years period following the acquisition, an increase in technical efficiency of the order of 10%. This result is statistically significant and proves to be robust with respect to the inclusion of size and calendar year effects as explanatory variables of firms' inefficiency. These findings contribute to the debate on the welfare gains of ownership changes by providing evidence that mergers and acquisitions lead to cost savings, due to the reduction of acquired firms' X‐inefficiency. Copyright © 2002 John Wiley & Sons, Ltd.     

Measuring technical and scale inefficiencies in the beer industry: Nonparametric and parametric evidence

Two alternative approaches of efficiency measurement, nonparametric and statistical, are employed to calculate three types of efficiency indexes for the U.S. beer industry over the period 1950–1986. The results indicate that the beer industry was operating at a high level of pure technical efficiency over that period. The mean value of this efficiency measure is 93.7 percent based on the nonparametric approach and 87.5 percent based on the statistical approach. The two approaches yield dissimilar values and sources for overall technical inefficiency. The overall technical efficiency index computed under the nonparametric approach stands at 91.10 percent and the observed inefficiency is found to be more due to pure technical inefficiency than to scale inefficiency. Using the statistical approach, the beer industry is found to be less overall technically efficient (68.42 percent) than indicated by the nonparametric methodology and the observed inefficiency is found to be primarily contributed to by scale inefficiency.     

Decentralized environmental regulations and plant‐level productivity

Using the framework provided by the Porter hypothesis, we study the impact of environmental regulations and enforcement policies on plant‐level green total factor productivity (TFP) growth and its components related to efficiency change and technical change. The detailed microdata we use are from Sweden and for the pulp and paper industry. This industry is the source of significant amounts of water and air pollution and is one of the most heavily environmentally regulated manufacturing industries. Sweden has a unique decentralized regulatory structure where the manufacturing plants have to comply with plant‐specific regulatory standards stipulated at the national level, as well as decentralized local supervision and enforcement. Our empirical results point to beneficial impacts of the environmental policies on plants' green TFP growth and sustainable production practices. We also find that political economy considerations are important, as the presence of the Green Party and aspects like plant size (with corresponding local and regional economic effects) matter in enforcement of the standards.     

Competitive bidding and voucher payments for implementing the new federalism with special emphasis on programs for the aging.

Principles from the economics of decentralization are applied to the planning and budgeting of social services for the elderly. The standard model of corporate decentralized planning and budgeting is extended to allow different levels of government to pursue qualitatively different goals. A safety-net voucher plan is also proposed to protect the most vunerable population from possible termination of services due to poorly formulated local plans. Such a decentralized planning and budgeting system would make Federal and State influence on local plans proportional to their contribution to total expenditures.     

Soft budgets and hard rents: a note on Kornai and Gomulka

This note shows how Kornai's concept of the soft budget constraint can be decomposed into separate elements of technical inefficiency and relative price distortion. The distinction between r-budget softness and m-budget softness introduced by Gomulka is shown to correspond to the equivalent and compensating variation measures of efficiency loss. It is also argued that budget softness should be viewed as the outcome of a rent-seeking process in which a firm's action in the control sphere incurs an opportunity cost in the real sphere. Adopting such a perspective leads to a re-definition of the resource loss associated with budget softness and results in much higher estimates of the social costs of soft budgets than those proposed in the existing literature.     

A stochastic frontier analysis to estimate the relative efficiency of Spanish airports

There exists a common belief among researchers and regional policy makers that the actual central system of Aeropuertos Españoles y Navegación Aérea (AENA) should be changed to one more decentralized where airport managers could have more autonomy. The main objective of this article is to evaluate the efficiency of the Spanish airports using Markov chain Monte Carlo (MCMC) simulation to estimate a stochastic frontier analysis (SFA) model. Our results show the existence of a significant level of inefficiency in airport operations. Additionally, we provide efficient marginal cost estimates for each airport which also cast some doubts about the current pricing practices.     

Cost efficiency of insurance firms in Ghana

The huge infrastructural deficit in Africa requires the establishment of an efficient insurance industry in the pursuance of economic development. Unfortunately, global statistics reveal low patronage of insurance in developing countries, thus making its impact limited in the region. To position the industry for economic development, this study utilizes the stochastic frontier technique to undertake a thorough analysis on the cost efficiency of insurers from the perspective of developing economies using Ghana as a case study. The results on the 30 insurers studied from 2005 to 2014 indicate that insurers in Ghana operate with about 53.8% average cost inefficiency. This stands to confirm the long existed low performance perception of Ghanaians about the industry. Factors identified to explain the cost inefficiencies were firm size, market share, capitalization, reinsurance, regulation, and business type. Several policy recommendations that can help boost the cost efficiency of insurers were derived from the results.     

The impact of privatization and regulation on the water and sewerage industry in England and Wales: a translog cost function model

After the ten Regional Water Authorities (RWAs) of England and Wales were privatized in November 1989, the successor Water and Sewerage Companies (WASCs) faced a new regulatory regime that was designed to promote economic efficiency while simultaneously improving drinking water and environmental quality. As legally mandated quality improvements necessitated a costly capital investment programme, the industry's economic regulator, the Office of Water Services (Ofwat), implemented a retail price index (RPI)+K pricing system, which was designed to compensate the WASCs for their capital investment programme while also encouraging gains in economic efficiency. In order to analyse jointly the impact of privatization, as well as the impact of increasingly stringent economic and environmental regulation on the WASCs' economic performance, this paper estimates a translog multiple output cost function model for the period 1985–1999. Given the significant costs associated with water quality improvements, the model is augmented to include the impact of drinking water quality and environmental quality on total costs. The model is then employed to determine the extent of scale and scope economies in the water and sewerage industry, as well as the impact of privatization and economic regulation on economic efficiency. Copyright © 2000 John Wiley & Sons, Ltd.     

Cost and profit efficiency of conventional and Islamic banks in GCC countries

Using stochastic frontier approach, this paper investigates the cost and profit efficiency levels of 71 commercial banks in Gulf cooperation council countries over the period 1999–2007. This study also conducts a comparative analysis of the efficiency across countries and between conventional and Islamic banks. Moreover, we examine the bank-specific variables that may explain the sources of inefficiency. The empirical results indicate that banks in the Gulf region are relatively more efficient at generating profits than at controlling costs. We also find that in terms of both cost and profit efficiency levels, the conventional banks on average are more efficient than Islamic banks. Furthermore, we observe a positive correlation of cost and profit efficiency with bank capitalization and profitability, and a negative one with operation cost. Higher loan activity increases the profit efficiency of banks, but it has a negative impact on cost efficiency.     

Corporate greening and changing regulatory regimes: the UK water industry

This article looks at the relationship between economic regulation, environmental regulation, company strategy and the environment in the UK water and sewerage industry. The regulatory field in this industry, following privatization in 1989, is highly complex and interdependent. The paper presents three case studies of company interpretation of and response to changes in this regulatory field, focusing particularly on the third review by the economic regulator, in 1999, which involved a reduction of the prices companies were allowed to charge their customers. This had significant but complex repercussions for environmental strategy and management in the companies, with different impacts on mandatory and non‐mandatory activities. It also showed in relief the opportunities for building coalitions between companies and the environmental regulator, both in general terms and revolving around specific, local environmental issues and schemes. Companies' strategic direction was also found to have an impact on their response to the regulatory review. Copyright © 2007 John Wiley & Sons, Ltd and ERP Environment.     

Fixed and Random Effects in Stochastic Frontier Models

Received stochastic frontier analyses with panel data have relied on traditional fixed and random effects models. We propose extensions that circumvent two shortcomings of these approaches. The conventional panel data estimators assume that technical or cost inefficiency is time invariant. Second, the fixed and random effects estimators force any time invariant cross unit heterogeneity into the same term that is being used to capture the inefficiency. Inefficiency measures in these models may be picking up heterogeneity in addition to or even instead of inefficiency. A fixed effects model is extended to the stochastic frontier model using results that specifically employ the nonlinear specification. The random effects model is reformulated as a special case of the random parameters model. The techniques are illustrated in applications to the U.S. banking industry and a cross country comparison of the efficiency of health care delivery.JEL classification: C1, C4     

Measuring technical and allocative inefficiency in the translog cost system: a Bayesian approach

In this paper, we propose simulation-based Bayesian inference procedures in a cost system that includes the cost function and the cost share equations augmented to accommodate technical and allocative inefficiency. Markov chain Monte Carlo techniques are proposed and implemented for Bayesian inferences on costs of technical and allocative inefficiency, input price distortions and over- (under-) use of inputs. We show how to estimate a well-specified translog system (in which the error terms in the cost and cost share equations are internally consistent) in a random effects framework. The new methods are illustrated using panel data on U.S. commercial banks.     

A new method to decompose profit efficiency: an application to US commercial banks

We propose a new method to estimate profit efficiency which makes explicit how revenue and cost efficiencies contribute to overall profit efficiency. Using data from US commercial banks from 2001 to 2010, we find that losses due to profit inefficiency represent about 3.5% of banks’ equity of which 1% is due to revenue inefficiency and 2.4% to cost inefficiency. Revenue efficiency changes affect more overall profit efficiency than equivalent cost efficiency changes. In contrast to previous studies, but in line with economic intuition, we find that while revenue and cost efficiencies tend to be negatively correlated, both correlate positively with profit efficiency.     

Ownership structure and cost efficiency: A study of publicly owned passenger-bus transportation companies in India

This paper estimates the determinants of cost inefficiency of several publicly operated passenger-bus transportation companies in India in terms of their ownership structure as well as other firm-specific characteristics. A panel data on publicly operated passenger-bus transportation companies is used to estimate a translog cost system with inefficiency. Inefficiency is specified in such a way that both its mean and variance are firm- and time-specific. For the estimation of production technology and cost inefficiency we have used a multi-step estimation procedure instead of the single-step maximum likelihood (ML) method. In the first step we estimate the translog cost system with heteroskedastic cost function without using any distributional assumptions on the error terms. The second stage uses the ML method to estimate the parameters associated with inefficiency, conditional on the parameter estimates obtained from the first stage. Finally, the residual of the cost function is decomposed to obtain firm-and time-specific measures of cost inefficiency, with ownership type and other firm-specific characteristics as explanatory variables.Financial support of the Nevada Agricultural Experiment Station is gratefully acknowledged.     

new pricing in the pipeline

Ian Byatt, Director General of Water Supply, explains how the water and sewerage industry is regulated.     

Assessing the productivity of the Italian hospitality sector: a post-WDEA pooled-truncated and spatial analysis

This paper analyses the productivity of the hospitality sector (hotel and restaurants) in Italy at a regional level by using a mix of non-parametric and parametric approaches. A novel pooled-truncated and spatial analysis is employed, based upon a window data envelopment analysis (WDEA), where pure technical efficiency is computed. The WDEA results show that Lombardy is the best relative performer. However, overall Italian regions reveal important sources of inefficiency mostly related to their inputs. As a post-WDEA, the pooled-truncated estimation indicates that the rate of utilisation and regional intrinsic features positively affect hospitality efficiency. Nevertheless, the spatial analysis does not support evidence of spill-over effects amongst Italian regions.     

Mafia risk perception: Evaluating the effect of organized crime on firm technical efficiency and investment proclivity

The presence of illegal organizations in economic development settings contributes to the Italian economy’s regional heterogeneity by exacerbating other inefficiencies. We aim to investigate how three indicators of awareness of criminal interest in a firm’s activities affect the latter’s efficiency, as well as examining a potential channel through which illegal activities could hinder firm performance, using a unique set of firm-level data. According to our findings, the presence of criminal network pressure in a firm’s environment reduces its technical efficiency and propensity to invest. This phenomenon is particularly strong in Italy’s underdeveloped regions, across all illicit considered and risk classes, with inefficiency doubling when the fear of crime becomes significant. A similar pattern emerges in terms of firm investment proclivity. The research findings are relevant for policymakers because they demonstrate that even the perception of a criminal threat has significant effects on a firm’s performance; consequently, enhancing legal protection could prevent significant economic and social costs.