An Investigation of Life Insurer Efficiency in Canada

Abstract

This paper explores the effect of the cost and profit efficiency of Canadian life insurers on their return on equity (ROE). We take the data submitted by these insurers to the Office of the Superintendent of Financial Institutions (OSFI) for 2000 through 2004 and determine 1) the extent of the profit and cost efficiency of the various Canada life insurers and 2) how this affects their ROE. We also explore how other factors such as company size, debt ratio and amount of new business written affect ROE. The values are determined using stochastic frontier analysis for both companies as a whole and separately for the various lines of business (LOBs) within the companies. The results of the investigation show us that both the profit and cost efficiency is very important in determining the ROE of a life insurer as a whole and is much more so than the other factors explored. Indeed the average inefficiency of the insurers reduces their average ROE anywhere from 11% to 38% of its potential value depending upon the method of measurement used. It is found that in order to increase its ROE by even 1% (e.g. from 10% to 11%) by adjusting its size, debt ratio or amount of new business written it is (virtually) impossible for a life insurer and the only reasonable way to do so is by improving its efficiency. In addition profit efficiency by LOB is seen, for the most part, to be important in determining the ROE of the LOB and is also more so than the other factors explored. There are some LOBs where the importance of profit efficiency is difficult to determine, mostly because of a lack of data.