Shuji Yao, Zhongwei Han and Dan Luo
IDENTIFICATION OF RETURNS TO SCALE As demonstrated in Chapter 4, the VRS model generates pure efficiency scores and the CRS model works out technical efficiency scores. Their difference is caused by scale economies. Insurance companies would be interested to know whether their scale is optimal and how the impact of scale economy on technical efficiency can be measured. Other managerial issues addressed in this chapter include how to evaluate a drop in the efficiency score in a dynamic context. Are there any super-efficient insurers that dominate other efficient companies? In what circumstances is merger or acquisition beneficial to the insurer? As the income approach and the RSRB approach are interrelated and have similar results, the following discussion will focus only on the income approach. In previous chapters, it was assumed that an efficient DMU should operate under CRS. At an IRS production point, the firm raising its input levels by a small percentage will lead to an expansion of its output levels by a much larger percentage, while in the DRS situation a small expansion of output levels would require a larger percentage rise in input level. Therefore, when IRS holds, the insurer should increase its scale, whereas for DRS companies a cutback of scale is necessary. The ideal scale to operate at is where CRS holds. To identify the nature of returns to scale of an insurance company in the input oriented envelopment model, Banker and Thrall (1992) prove the following conditions need to be satisfied: ● ● ● if g l...
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