Deregulation, Consolidation, and Efficiency: Evidence from the Spanish Insurance Industry
Cummins, J. David, Rubio-Misas, Maria, Journal of Money, Credit & Banking
FINANCIAL SERVICES markets have changed significantly over the past two decades, following the deregulation of banking, insurance, and other financial services in major industrialized nations. The introduction of the European Union's (EU's) Second Banking Directive (1993) and Third Generation Insurance Directive (1994) aimed at deregulating the EU banking and insurance markets, respectively. Japan initiated financial system deregulation with the "Big Bang" financial reforms, launched in 1996; and U.S. regulations were relaxed in stages, culminating in the Granun-Leach-Bliley Act of 1999. Common themes of these deregulatory efforts include the removal of restrictions on ownership of different types of financial services firms, the relaxation of geographical restrictions on branching and sales, and price deregulation. (1)
The principal objective of financial services deregulation is to improve market efficiency and enhance consumer choice through increased competition. Efficiency gains can occur as a result of the market consolidation that has accompanied deregulation, particularly in Europe and the U.S. Consolidation has the potential to improve X-efficiency in an industry if it results in poorly performing firms exiting the market, either through voluntary or involuntary withdrawal or through mergers and acquisitions (M&As). Consolidation also can positively affect efficiency if it permits firms to take advantage of scale economies to reduce unit costs of production. In spite of the significant potential for efficiency gains from consolidation, the research evidence on the efficiency effects of consolidation has been mixed, with some studies showing efficiency gains and others showing no efficiency gains or efficiency losses (Berger and Humphrey 1997, Berger, Demsetz, and Strahan 1999, Grifell-Tatje and Lovell 1996).
The objective of the present paper is to provide additional information on the effects of deregulation and consolidation on financial services market efficiency by analyzing the Spanish insurance industry. The Spanish industry has been affected by the overall deregulation of European insurance markets, particularly through the EU's Third Generation Insurance Directives, implemented in July 1994. The Third Directives effectively deregulated the EU insurance market, with the exception of solvency regulation, which is carried out by the insurer's home country. The market changes have been particularly significant in Spain because the government began tightening solvency standards and encouraging M&As in the insurance industry even prior to the adoption of the Third Generation Directives, under a 1984 law and a 1985 Royal Decree. The 1980s Spanish deregulation was designed to create insurers who would be financially stronger, more efficient, and more competitive both nationally and internationally. As a result of these regulatory changes, the number of insurers operating in the Spanish market declined dramatically during both the 1980s and 1990s. Nevertheless, many small niche-market insurers remained in the market at the end of the 1990s, specializing in particular product lines and/or geographical regions within Spain.
Government policies encouraging consolidation make sense economically if larger firms tend to be more X-efficient, if there are unrealized scale economies, and/or if consolidation leads to more vigorous competition that increases market efficiency. The purpose of this paper is to analyze scale economies and efficiency in the Spanish insurance industry to determine whether deregulation has had the intended effects.
We analyze the Spanish insurance industry over the ten-year period 1989-98. We measure efficiency by estimating "best practice" production and cost frontiers for each year of the sample period, using data envelopment analysis (DEA), a nonparametric technique (Cooper, Seiford, and Tone 2000). A production frontier gives the minimum inputs required to produce any given output vector, while the cost frontier measures the minimum costs to produce the output vector. …