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Effects of Risk Management on Cost Efficiency and Cost Function of the U.S. Property and Liability Insurers

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  • Hong-Jen Lin
  • Min-Ming Wen
  • Charles Yang

Abstract

This paper adopts the one-step stochastic frontier approach to investigate the impact of risk management tools of derivatives and reinsurance on cost efficiency of U.S. property-liability insurance companies. The stochastic frontier approach considers both the mean and variance of cost efficiency. The sample includes both stock and mutual insurers. Among the findings, the cost function of the entire sample carries the concavity feature, and insurers tend to use financial derivatives for firm value creation. The results also show that for the entire sample the use of derivatives enhances the mean of cost efficiency but accompanied with larger efficiency volatility. Nevertheless, the utilization of financial derivatives mitigates efficiency volatility for mutual insurers. This research provides important insights for the practice of risk management in the property-liability insurance industry.

Suggested Citation

  • Hong-Jen Lin & Min-Ming Wen & Charles Yang, 2011. "Effects of Risk Management on Cost Efficiency and Cost Function of the U.S. Property and Liability Insurers," North American Actuarial Journal, Taylor & Francis Journals, vol. 15(4), pages 487-498.
    • Handle: RePEc:taf:uaajxx:v:15:y:2011:i:4:p:487-498
    DOI: 10.1080/10920277.2011.10597634
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    Cited by:

    1. Shiu, Yung-Ming, 2020. "How does reinsurance and derivatives usage affect financial performance? Evidence from the UK non-life insurance industry," Economic Modelling, Elsevier, vol. 88(C), pages 376-385.

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