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Optimal Capital Utilization by Financial Firms: Evidence from the Property-Liability Insurance Industry

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Abstract

Capitalization levels in the property-liability insurance industry have increased dramatically in recent years—the capital-to-assets ratio rose from 25% in 1989 to 35% by 1999. This paper investigates the use of capital by insurers to provide evidence on whether the capital increase represents a legitimate response to changing market conditions or a true inefficiency that leads to performance penalties for insurers. We estimate “best practice” technical, cost, and revenue frontiers for a sample of insurers over the period 1993–1998, using data envelopment analysis, a non-parametric technique. The results indicate that most insurers significantly over-utilized equity capital during the sample period. Regression analysis provides evidence that capital over-utilization primarily represents an inefficiency for which insurers incur significant revenue penalties.

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Authors and Affiliations

  1. The Wharton School, University of Pennsylvania, U.S.A

    J. David Cummins & Gregory P. Nini

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  1. J. David Cummins
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  2. Gregory P. Nini
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Cummins, J.D., Nini, G.P. Optimal Capital Utilization by Financial Firms: Evidence from the Property-Liability Insurance Industry. Journal of Financial Services Research 21, 15–53 (2002). https://doi.org/10.1023/A:1014369617192

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