Academic journal article The Lahore Journal of Economics

Cost Efficiency and Total Factor Productivity: An Empirical Analysis of Pakistan's Insurance Sector

Academic journal article The Lahore Journal of Economics

Cost Efficiency and Total Factor Productivity: An Empirical Analysis of Pakistan's Insurance Sector

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1. Introduction

The insurance sector plays a diverse role by supporting individuals, entrepreneurs and companies confronting multiple risks in addition to its role as a financial intermediary. A well-organized insurance sector is essential to promote sustainable economic growth and stabilization by fostering capital mobilization as well as efficient investment through financial markets (State Bank of Pakistan, 2005). Despite the importance of the insurance sector in Pakistan's socioeconomic development and its distinct functions relative to other financial institutions, it has not received much attention from policymakers. The sector remains underdeveloped and considerably small in terms of premiums, insurance density and penetration.1

Insurance penetration in Pakistan is substantially low at US$ 6.6 with a density of 0.7 percent in 2009 in comparison with peer countries and across the region. For instance, insurance penetration and density in India were US$ 54.3 and 5.2 percent in 2009, respectively (Swiss Re, 2010). The low density and dissemination of the insurance business in Pakistan may be a result of the country's low income per capita, general lack of awareness of the importance of insurance, the sharp increase in the cost of living, a low savings rate, inflation, and religious and other cultural factors.

Following the financial liberalization of the early 1990s, Pakistan opened its insurance market to domestic and foreign insurers. However, it was not until the early 2000s that the private insurance sector experienced a growth momentum with the development of its business and domestic firms. The insurance industry in Pakistan has become fairly developed in recent years by transforming from a monopolistic to a competitive market. Like other financial institutions, the insurance industry has also undergone deregulation, but the pace of implementation has been sluggish. As a result, it is the component of the financial sector with the highest share of government ownership (State Bank of Pakistan, 2010).

The growth of the insurance industry and its economic importance has attracted research interest in the wake of financial sector reforms.2 While a rich and diverse body of literature focuses on insurance efficiency in developed economies, few studies have measured the performance of the insurance sector in developing countries (see, for example, Mansoor & Radam, 2000; Kao & Hwang, 2008), particularly in Pakistan. The present study examines the performance of Pakistan's insurance industry to gauge whether financial sector reforms have improved its efficiency and productivity, and to determine which factors are responsible for these.

Specifically, we concentrate on estimating its cost efficiency, decomposition (into technical and allocative efficiency) and total factor productivity (TFP). We also correlate various factors that influence the efficiency of the insurance sector, such as ownership structure, various services offered (life and nonlife insurance policies) and profitability indicators. Thus, the study contributes to the literature on insurance sector efficiency in developing countries in general and Pakistan in particular. It also provides insights into avenues for future research.

Section 2 provides an overview of the insurance sector in Pakistan. Section 3 reviews the relevant literature on efficiency. Section 4 discusses the methodology followed. Section 5 describes the selected variables. Section 6 analyzes the empirical results and Section 7 concludes the paper.

2. An Overview of Pakistan's Insurance Sector

Pakistan's insurance sector has a long history that goes back to independence, at which time, the sector was heavily dominated by foreign insurance companies. There were 77 foreign companies operating in Pakistan compared to seven domestic companies, most of them state-owned. In 1953, the Government of Pakistan set up the Pakistan Insurance Corporation to encourage local insurers to participate. …

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