On the Cost Structure of the Japanese Property-Casualty Insurance Industry

By Hirao, Yukiko; Inoue, Tomoo | Journal of Risk and Insurance, September 2004 | Go to article overview

On the Cost Structure of the Japanese Property-Casualty Insurance Industry


Hirao, Yukiko, Inoue, Tomoo, Journal of Risk and Insurance


ABSTRACT

This article tests economies of scale and economies of scope for the property-casualty insurance companies in Japan. We fit a composite cost function to a set of Japanese firms over the period from 1980 to 1995 and employ an error components model. Our main findings are as follows. First, statistically significant economies of scale are observed in both Japanese firms and foreign firms operating in Japan. Second, economies of scope are also statistically significant for Japanese firms and most of the foreign insurers between the "third sector" products and the rest of the property-casualty insurance lines.

INTRODUCTION

The Japanese property-casualty (hereafter P/C) insurance industry is currently undergoing major changes due to deregulation. Until the mid 1990s, entry into the insurance industry was tightly regulated, and insurance firms in Japan, including foreign companies operating in Japan, were legally required to use premium rates set by the insurance rating organization to sell fire, earthquake, personal accident, automobile, and compulsory automobile liability insurance. The industry was highly concentrated. In 1995, 26 Japanese P/C insurance firms and 29 foreign firms were in Japan. (1) The market share of the four largest firms in the industry (all Japanese) received roughly 47 percent of the premium income.

Then the "Financial Big Bang" (a series of financial deregulations taking place in the 1990s in Japan) and the U.S.-Japan Insurance Talks concluded in 1996 brought about major changes in the industry. The premium rates were gradually liberalized, with full liberalization taking effect in 1998. Foreign P/C insurance firms operating in Japan started offering low-priced insurance. The Insurance Business Law revised in 1995 removed the restriction on mutual entry between the life and P/C insurance sectors. Afterwards, several life insurance companies started offering fire and automobile insurance via newly established subsidiaries, and P/C insurance firms started selling life insurance via their new subsidiaries. Profitability of the P/C insurance companies declined gradually over the 1990s; the average ROE of the 20 Japanese P/C insurers included in our data set exceeded 14 percent every year until 1990 but decreased to 12.6 percent in 1991, 7.5 percent in 1993, 5.5 percent in 1995 (the last year of our study), 4.5 percent in 1997, and to 2.4 percent in 2000. (2)

This article empirically investigates the cost structure of the P/C insurance firms in Japan for 1980-1995. We estimate economies of scale in the Japanese and the foreign-owned P/C insurers operating in Japan using a panel data set. From an industrial organization perspective, discovery of significant scale economies is important, since small- and medium-size firms may find it difficult to withstand increased competition from deregulation; in the long run only a few firms will survive. In fact, there was a wave of mergers between prominent Japanese P/C insurance firms in 1999 and 2000. As of Spring 2002, the set of insurers that have agreed to merge with each other are Mitsui MFI and Sumitomo MFI (MFI stands for Marine & Fire Insurance), the third and fourth largest firms in the P/C insurance industry in terms of total assets; Nippon FMI and Koa FMI (FMI stands for Fire & Marine Insurance), the fifth and eighth largest firms; Dai-Tokyo FMI and Chiyoda FMI, the seventh and ninth largest companies; and Yasuda FMI (the second largest P/C insurer) and midsize Nissan FMI and Taisei FMI. The P/C insurance industry giant Tokio MFI announced a comprehensive partnership with Nichido FMI (the sixth largest) and Asahi Mutual Life Insurance, a life insurer. This is the first time in the history of the Japanese P/C insurance industry in which consolidations occurred on such a major scale. Also, in 2000, Dai-Ichi Mutual FMI became the first Japanese P/C insurance firm to become insolvent and go out of business. …

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