Lih-Ru Chen National Chengchi University Gene C. Lai Washington State University Jennifer L. Wang

1. Nonspecialized Strategy versus Specialized Strategy：Evidence from the Property-Liability Insurance Industry Lih-Ru Chen National Chengchi University Gene C. Lai Washington State University Jennifer L. Wang National Chengchi University ARIA Meeting, August, 2007

2. Research Question and Research Purpose • Why do we observe the long-lived coexistence of joint producers and specialist in the U.S. property-liability insurance industry? • Whether joint producers or specialist is more efficient ? • whether nonspecialized strategy or specialized strategy is more efficient for property-liability insurers. • what types of insurers are likely to realize economies of scope.

3. The Literature I • Conglomeration hypothesis • Teece(1980) • Argued that Multiproduct enterprise is an efficient way of organizing economic activity. • Panzar and Willing (1981) • First to introduce the concept of economies of scope. • Strategic focus hypothesis • Comment and Jarrell (1995) • The greater corporate focus is consistent with shareholder wealth maximization. • Kanatas and Qi (2003) • Integrated financial services market is less innovative than one with specialized intermediaries. • Chen (JFQA,2006) • focused firms exhibit significantly better post-investment operating performance than diversified firms.

4. The Literature II Insurance Related • Kellner and Mathewson (1983); Meador, Ryan, and Shellhorm (1998), Cummins, Weiss, and Zi (2003), and Hirao and Inoue (2004) found results consistent with diversification strategy. • Grace and Timme (1992) and Yuengert (1993) • Berger et al. (2000) found mixed results. • Jeng and Lai (2005) find that Keiretsu firms seem to be more cost-efficient than nonspecialized independent firms.

5. The main contribution of this study • This paper examines diversification/focus strategy from the perspective of a property-liability insurer rather than two sectors of insurance industry. • We examines whether the technology of nonspecialists is the same as that of the specialists using the cross-frontier approach. • Focusing on a more recent time period enables us to determine whether the most recent wave of financial consolidation will change the focus strategy.

6. Data and Methodology Sample & Data • Period: 1997-2004 • Insurer’s Annual Statement from NAIC • Herfindahl index of net premium is used to identify the specialists and nonspecialists. Methodology • Data Envelopment Analysis (DEA) • Stochastic Frontier Approach (SFA)

7. Hypotheses Development • H1: The Nonspecialized Hypothesis • H2: The Specialized Hypothesis • H3: The technology of nonspecialists is the same as that of the specialists. • H4: It is infeasible to replicate nonspecialists input-output bundle using the specialists technology. • H5: There are no scope economies for either nonspecialists or specialists.

8. Inputs/Outputs using in value-added approach

9. Table 1 Summary Statistics for non-specialists and specialists Note:*** Statistically significant difference at 1% level or better; ** Statistically significant difference at 5% level; * Statistically significant difference at 10% level.

10. Table 5 Cost efficiency results: 1997–2004

11. Table 5 Cost efficiency results: 1997–2004 (continuous) Note:*** Statistically significant difference at 1% level or better; ** Statistically significant difference at 5% level; * Statistically significant difference at 10% level.

12. Cummins et al., (1999) • F-scores measure the dominance with respect to the frontiers.

13. Table 7 Dominance Statistics by Size Quartile Note:*** Statistically significant difference at 1% level or better; ** Statistically significant difference at 5% level; * Statistically significant difference at 10% level.

14. Table 8 Summary Statistics for regression Note:*** Statistically significant difference at 1% level or better; ** Statistically significant difference at 5% level; * Statistically significant difference at 10% level.

15. Table 9 Dominance Regression for nonspecialists and specialists Note:*** Statistically significant difference at 1% level or better; ** Statistically significant difference at 5% level; * Statistically significant difference at 10% level.

16. SFA variables

17. Table 10 Summary Statistics for stochastic frontier approach Note:*** Statistically significant difference at 1% level or better; ** Statistically significant difference at 5% level; * Statistically significant difference at 10% level.

18. Table 11 Scope Economy by Quartile Note:*** Statistically significant difference at 1% level or better; ** Statistically significant difference at 5% level; * Statistically significant difference at 10% level.

19. Table 12 Profit Scope Economy Regression for simulated non-specialists Note:*** Statistically significant difference at 1% level or better; ** Statistically significant difference at 5% level; * Statistically significant difference at 10% level.

20. Concluding remarks • Supports for Hypothesis1,2,4 are found. • The nonspecialists and specialists operate on different efficient frontiers in P/L insurance industry. • Nonspecialists (specialists) dominate specialists (nonspecialists) in producing nonspecialists (specialists) input–output vectors. • The regression results generally support the coexistence of the nonspecialized strategy and specialized strategy.