Economies of Scope in Financial Services : A DEA Efficiency Analysis of the US Insurance Industry

This paper investigates economies of scope in the US insurance industry over the period 1993-2006. We test the conglomeration hypothesis, which holds that firms can optimize by operating a diversity of businesses, versus the strategic focus hypothesis, which holds that firms can best add value by focusing on core competencies. We analyze whether it is advantageous for firms to diversify by offering both life-health and property-liability insurance or to specialize in one major industry segment. We estimate technical, cost, revenue, and profit efficiency utilizing data envelopment analysis (DEA) and test for scope economies by regressing efficiency scores on an indicator variable for strategic focus and control variables. Property-liability insurers realize cost scope economies, but they are more than offset by revenue scope diseconomies. Life-health insurers realize both cost and revenue scope diseconomies. Hence, strategic focus is superior to conglomeration in the insurance industry