Both specialization and diversification can be successful strategies in the insurance business. In fact, diversification is one of the fundamentals of our business because it helps spread risk, which allows for the shifting of risk for reasonable pricing. Diversification can be accomplished through a variety of approaches, including line of business, product line, geographic concentration and distribution diversification strategies. Certainly no one would argue that diversification is not imperative in writing catastrophe exposed property insurance.
However, specialization is also a strategy that provides some unique benefits, primarily the accumulation of a high degree of expertise in a particular specialty area (see our prior posts here & here). This expertise can be utilized in underwriting, risk management and claims to produce improved risk selection and reduced loss costs.
A recent study provides empirical evidence that a specialization strategy can produce better results than diversification. Published in The Journal of Risk and Insurance, the study, by Andre P. Liebenberg and David W. Sommer is entitled: Effects of Corporate Diversification: Evidence from the Property-Liability Insurance Industry. The study looks at line of business diversification within the property/liability insurance industry, concluding:
Undiversified insurers outperform diversified insurers…Results indicate that diversification is associated with a penalty of at least 1% of ROA or 2% of ROE.
It would be interesting to review the companies included in each grouping to see if there are any concentrations of types of business. Examples might include reinsurers and medical malpractice insurers.
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