The Impact of Deregulation on Efficiency: An Analysis of Life Insurance Industry in Taiwan from 1981 to 2004

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ABSTRACT

We examine the impact of deregulation and liberalization (D&L) on the efficiency of the Taiwanese life insurance industry from 1981 to 2004. We utilize the data envelopment analysis (DEA) to measure the efficiency performances and the Malmquist index approach to measure changes in efficiency and productivity over time. Both the DEA and Malmquist results show that the old domestic firms have been slightly impacted by the new competitors around 1992-1994 (the end of foreign and new local entry period and the beginning of post-D&L period). More important, our results show that the D&L does not have major adverse impact on the technical, cost, and revenue efficiency performances of existing domestic firms in the long run. The dominance of existing domestic firms has declined but persists throughout the sample period. In addition, our results show that it is relatively easy for new firms to become technically efficient in just few years after entering the market, but it is more difficult for them to become efficient in cost and revenue efficiency. We, thus, suggest that a new market entrant should take advantage of the existing mechanisms by acquiring an old (existing) firm, rather than establish a new one, if a new entrant wants to become efficient in cost and revenue efficiency in a short time.

INTRODUCTION

With the rapid emergence and continuing evolution of a global economy, any country that intends to play an important role in world trade must ultimately remove the protection and restrictions on its insurance market. Specifically, under the rules of the World Trade Organization (WTO) agreements regarding liberalization in the financial service industries, these developing countries have to balance dual goals of survival and free trade. On the one hand, the local governments are persuaded that deregulation and liberalization (D&L) will improve the efficiency of existing domestic companies and that the degree of competitiveness of the entire industry could be raised by the new technologies brought by new entrants. On the other hand, local governments always fear that the D&L will undermine the development of domestic industries and ultimately result in the failure of domestic firms. Which argument prevails is an empirical question.

Liberalization in the financial service industries also increases the incentive of global insurers to enter new markets because liberalization has lessened the entry barrier for local markets. If global insurers decide to enter a new market, then their very next question is to decide what the best method is to enter the market. In other words, is it better to enter a new insurance market by establishing a new insurer or to go through mergers and acquisitions with an existing domestic insurer?

We find that the insurance market in Taiwan provides an interesting study to answer the above two questions. Taiwan, being one of the potentially lucrative markets in global insurance, has followed a policy of gradual D&L in its insurance sector in the late 1980s. The life insurance industry in Taiwan was first established with eight domestic life insurance companies in 1962. The market remained closed to foreign entrants until 1987. In 1993, the government further allowed new domestic firms to enter the market for the first time. Since 1993, the Taiwanese insurance market has been going through the establishment of new firms and some mergers and acquisitions. Global insurers have shown interests in the eight old domestic firms. For example, Chinfon Insurance Company, one of the eight old domestic firms, was acquired by Prudential Life in 1998. In 2004,17 years after the first foreign insurer joined Taiwan's life insurance industry, there were 29 life insurers in Taiwan, with 16 of them domestic and 13 of them foreign. The insurance premium increased from NT$80 billion (US$2.67 billion) in 1987 to NT$1,308 billion (US$41 billion) in 2004.

The purpose of this article is to examine the impact of D&L on the efficiency of the life insurance industry. …