The Measurement of Output and Economies of Scale in Property-Liability Insurance

Abstract

The conflicting results from previous studies of economies of scale might arise partly from the choice of output measure. This paper discusses conceptual and econometric problems arising from the use of premium income as a proxy for output. This output measure is not independent of the firm's pricing policy and its use implies potentially serious problems of simultaneous equation bias and errors in variables. It is argued that a delivery-based output measure is theoretically superior and will encounter less severe econometric problems. Cost functions estimated with the delivery-based measure do reveal significant scale economies in the Canadian property-liability insurance industry.