Analyzing Firm Performance in theInsurance Industry Using Frontier Efficiency Methods

In analysing insurance firms, it is often important to measure their performance relative to other firms in the industry. Traditionally, this has been done using conventional financial ratios such as the return on equity, return on assets, expense to premium ratios, etc. With the rapid evolution of frontier efficiency methodologies, the conventional methods are rapidly becoming obsolete. Frontier methodologies measure firm performance relative to “best practice” frontiers consisting of other firms in the industry. In the future, tests of economic hypotheses about insurers about such matters as organizational form, distribution systems, economies of scale and scope, and the effects of mergers and acquisitions will not be convincing unless they involve the use of one or more frontier-based performance measures. Such measures dominate traditional techniques in terms of developing meaningful and reliable measures of firm performance. They summarize firm performance in a single statistic (for a given type of efficiency) that controls for differences among firms in a sophistic ad multidimensional framework that has its roots in economic theory.