Technical, Pure Technical and Scale Efficiency: A Non Parametric Approach of Pakistans Insurance and Takaful Industry
Year: 2018

In this modern era of advanced technology, financial sector becomes a backbone of each and every economy. The financial sector is playing its significant role in mitigating the risk factors but the risk is the main ingredient of most of the business ventures. On the other hand stock market provides the investment opportunities to its investors. The financial chaos of 2007 2008 changed the worldview of the financial market (Harrington, 2009) Thus, experts are compelled to think about the alternative system rather than the conventional one. Islamic financial system, considered as alternative system got more attention than the other alternatives which are available in the financial market. Islamic financial institutions have shown their resilience during the financial distress of 2007 2008. Financial gurus, experts, academicians and policymakers are keen to analyse the different dimensions of the Islamic financial systems and they have shown their interest in the development of the different products and innovations (Chapra, 2011) Currently most of the Islamic Financial Institutions are launching new products which are compatible with the prevailing conventional system; most of their products are asset based or Shari'ah compliant. Almost 20% annual growth of Islamic finance has been observed (Chapra, 2008) In the current literature, the academicians and financial experts are trying to compare the performance of the Islamic and conventional financial institutions. A number of studies discussed this behaviour by using different methodologies and observed different findings. Quite a number of studies found that Islamic financial institutions are more efficient, for example, Azhar Rosly and Afandi Abu Bakar (2003) found for Malaysia, (El Gamal and Inanoglu (2004) El Gamal and Inanoglu (2005) estimated for Turkey, El Moussawi and Obeid (2011) for GCC, Sufian and Chong (2008) observed more efficient than conventional institutions in Malaysia, Ul Haque and Mirakhor (1986) observed that these are more stable and contributing to the growth of the economy whereas Beck, Demirguc Kunt and Levine (2010) found Islamic financial institutions are comparatively cost effective. It is well observed that Islamic banking industry is passed its infancy stage and moving towards its maturity, however, still Islamic insurance industry (Takaful) is passing the phase of infancy. The concept of cooperative risk sharing is the oldest form of insurance but the term and concept of takaful were first introduced in Sudan in 1979 and later on in Saudi Arabia. Now takaful is operating its business in more than 22 countries and getting popularity in other regions (Qureshi, 2011) Majma al Fiqh, the Grand Council of Islamic Scholars, Saudi Arabia, approved takaful as an alternate to insurance according to the shari'ah ruling in 1985 and Takaful industry has its global volume US $25 billion with only 305 takaful retakaful operators and windows. However, it is worthwhile to note that the growth of takaful industry is 12% per annum which higher than the conventional insurance industry which is only 4% per annum "Annual Islamic Financial Services Industry Stability Report" 2017) At the time of independence in 1947, 84 insurance companies were operative in Pakistan but the insurance industry was nationalized in 1972 and merged into State Life of Pakistan. However there was a major breakthrough in the 1990s, the financial reforms took into place and these reforms allowed private and foreign companies to establish their business in the insurance sector (Malik, Malik Faridi, 2011; "State Bank of Pakistan" 2005) The Council of Islamic Ideology in Pakistan reviewed the model for Pakistan's financial sector according to the shari'ah rulings, on 29th April 1992 (Khan, 2016) and the Government of Pakistan issued "Takaful Rules 2005' on 3rd September 2005, an Islamic compatible takaful operational model. Since then, takaful industry established and currently, two family takaful and three general takaful firms are in operation. It attracts the new customers because of its shari'ah compliance "Securities and Exchange Commission of Pakistan," 2016) Although like other parts of the world efficiency analysis have been conducted in Pakistan accounting for Insurance sectors as Takaful sector has started in Pakistan in 2005 and it is an infant industry and the studies of the efficiencies including Technical, Pure Technical and Scale efficiencies are lacking for a responsible period of time for Pakistan. This study will try to fill the gap by taking data of Pakistani Insurance companies from 2007 2016 with panel based comparative analysis further decomposing the sector into Conventional and Islamic. The primary objectives of this paper are to present the efficiencies of Insurance sector by evaluating Technical, Pure Technical and Scale efficiencies using Data Envelopment Analysis (DEA) by taking data from the period 2007 2016 and also to find any difference of efficiency in Islamic and Conventional segments of these sectors.  The efficiency measurement for the financial sector is one of the most rapidly growing literature in the market. A number of efficiency studies for the insurance sector, in particular, have been conducted and primarily employed two different approaches, namely, the parametric and non parametric approach. There are a number of studies measuring the efficiency of the insurance industry at a country level. A number of researchers estimated the efficiencies of the insurance industry of US. Gardner and Grace (1993) estimated the efficiency of the sample of 561 firms and found the inefficiencies for the different internal and external factors. Cummins and Xie (2013) estimated 781 property and liability of US insurance companies from 1993 to 2009 and found that the maximum firms are operating with a decreasing return to scale. Some of the researchers studied the European insurance industry including Fecher, Kessler, Perelman and Pestieau (1993) who estimated the efficiency of life and non life insurance companies of France for the period of 1984 to 1989 and found the non life insurer more efficient than the life insurers. Cummins and Turchetti (1996) estimated the efficiency and productivity growth of Italian insurance industry through the production frontier by applying parametric (SFA) approach and found the efficiency level between 70 to 78% Noulas, Lazaridis, Hatzigayios and Lyroudi (2001) and Cummins and Rubio Misas (2001) studied Greece and Spanish insurance industry simultaneously and found the firms operating with decreasing return to scale. Some researchers made the comparison of the insurance companies of the US and other European countries. Rai (1996) measured the X efficiencies of the insurance companies (life and non life) of nine European countries (France Switzerland, United Kingdom, Italy, Netherlands, Germany, Denmark, Finland, Sweden, one Asian (Japan) and US using the SFA technique between 1988 1992 and found the variation in the efficiencies on the basis of size, nature and location. Kasman and Turgutlu (2011) measured the efficiency of a group of countries by using the Stochastic Cost Frontier (SCF) covering the period 1995 2005 and found that small companies are more efficient than the large firms for the said countries. Some researcher worked on Asian and African insurance industry including Alhassan and Biekpe (2015) and Barros and Wanke (2014) examined the technical efficiency and capacity issues of the companies of South Africa and Mozambique found high technical inefficiency. Huang and Eling (2013) analysed the behaviour of the insurance companies of Brazil, Russia, India and China (BRIC Economies) and found that India is less technical efficient whereas Brazil is maximum efficient amongst them. Hu, Zhang, Hu and Zhu (2009) studied the efficiency of the insurance sector in China over the period of 1999 to 2004 and found the relationship between ownership structure and efficiency. Firms are mixed efficient, in the beginning and at the last, they perform efficiently whereas in the middle they were less efficient. The takaful is mostly being used in Muslim countries. Some of the researchers tried to calculate the efficiency of the takaful industry. Miniaoui and Chaibi (2014) presented a comparative analysis of GCC countries and Malaysia, from 20006 to 2009. They selected 12 takaful operators (three were from UAE, two from Saudi Arabia, two from Qatar, one from Bahrain and four from Malaysia) and found GCC market more efficient than Malaysia. Kader, Adams and Hardwick (2010) using DEA for evaluating the cost efficiency of 26 non life takaful firms from the sample of 10 Islamic countries and Cost efficiency score was 0.70. Some researcher computes the efficiency of insurance and takaful companies including Singh and Zahran (2013) who estimated the cost efficiency of both types of the insurance companies for the eight MENA countries, i.e. Bahrain, Egypt, Jordan, Kuwait, Qatar, Saudi Arabia and Tunisia. They concluded that takaful companies are less efficient due to Shari'ah compliant products. Janjua and Akmal (2015) compared the efficiency of both types of insurance (conventional and Islamic) companies operating in Pakistan over the period of 2006 2011. Saad (2012) examined the efficiency of conventional and Islamic insurance companies in Malaysia for 2007 2009 and concluded that the performance of takaful companies (Islamic Insurance Companies) was less than the average of the industry.