Efficiency, Scale Economies and Consolidation in the U.S. Life Insurance Industry

This paper examines the relationship between mergers and acquisitions, efficiency, and scale economies in the U.S. life insurance industry. We estimate cost and revenue efficiency for life insurers representing 80 percent of industry assets over the period 1988-1995 using data envelopment analysis (DEA) and decompose cost efficiency into pure technical, scale, and allocative efficiency. The Malmquist index methodology is used to measure changes in efficiency and productivity over time. The results support the hypothesis that acquired firms achieve greater efficiency gains than firms that have not engaged in merger or acquisition activity. We also find evidence that firms operating with non-decreasing returns to scale are more likely to be acquisition targets than firms operating with decreasing returns to scale. Firms with higher revenue efficiency are more likely to be acquired than firms with lower revenue efficiency, but we find no relationship between other types of efficiency and the probability that a firm is acquired. Financially vulnerable firms are more likely to be acquired than stronger firms. The overall conclusion is that mergers and acquisitions in the life insurance industry appear to be driven for the most part by economically sound objectives and have had a beneficial effect on efficiency in the industry