Regulator performance,regulatory environment and outcomes: An examination of insurance regulator career incentives on state insurance markets

In this paper we test whether the past or future labor market choices of insurance commissioners provide incentives for regulators in states with price regulation to either favor or oppose the industry by allowing prices that differ significantly from what would otherwise be the competitive market outcome. Using biographical data on insurance regulators, economic and state specific market structure and regulatory variables, and state premium and loss data on the personal automobile insurance market, we find no evidence consumers in prior approval states paid significantly different “unit prices” for insurance than consumers in states that allow competitive market forces to determine equilibrium prices during the time period 1985–2002. We do, however, find evidence regulators who obtained the position of insurance commissioner by popular election and those who seek higher elective office following their tenure as insurance commissioner allow higher overall “unit prices” relative to competitive market states. The “unit price” of insurance in regulated states is not statistically different from the competitive market outcome for regulators that make lateral moves back into state government and it is mildly higher for regulators who enter the insurance industry following their tenure. Finally, we find some evidence regulators who describe themselves as consumer advocates are successful reducing the price of insurance in favor of consumers in regulated markets. Overall the results are consistent with the existence of asymmetric information in the regulatory process that agents use to enhance their career aspirations.     

An Empirical Investigation of Market Structure, Efficiency, and Performance in Property-Liability Insurance

This study examines the relationships among market structure and performance in property‐liability insurers over the period 1992–1998 using data at the company and group levels. Three specific hypotheses are tested: traditional structure‐conduct‐performance, relative market power, and efficient structure (ES). The results provide support for the ES hypothesis. The ES hypothesis posits that more efficient firms can charge lower prices than competitors, enabling them to capture larger market shares and economic rents, leading to increased concentration. Both revenue and cost efficiency are used in the analysis, and this is the first study to use revenue efficiency in this type of analysis. The results for the sample period as a whole and by year are consistent. The overall results suggest that cost‐efficient firms charge lower prices and earn higher profits, in conformance with the ES hypothesis. On the other hand, prices and profits are found to be higher for revenue‐efficient firms. Revenue X‐efficiency is derived from activities such as cross‐selling and may rely heavily on the use of detailed information from customer databases to identify potential customers. The implications of this research are that regulators should be more concerned with efficiency (both cost and revenue) rather than the market power that arises from the consolidation activity taking place in insurance.     

The Cost of Duplicative Regulation: Evidence From Risk Retention Groups

A vast majority of insurers are regulated by each state in which they conduct business; however, a small subset of specialized firms, risk retention groups (RRGs), are largely exempt from most aspects of duplicative regulation no matter how many states they operate. This article analyzes the differences between RRGs and standard insurers specializing in commercial liability insurance to determine the cost of duplicative regulation. The costs associated with multi‐state regulation are significantly higher than those for single‐entity regulation. These high regulatory compliance costs reduce the technical efficiency of firms, deter firms from operating in additional states, and increase the price of insurance.     

Unfair Discrimination and Homeowners Insurance Availability: An Empirical Analysis

There has been an active public policy debate about the availability and cost of homeowners insurance in urban markets, and insurers have been charged with intentional discrimination, or redlining, against minority buyers and neighborhoods with a large proportion of minority population. Studies of relative price, loss costs, agency location, and product quality have attempted to determine whether insurers unfairly discriminate against minority homeowners in urban areas. This study focuses on insurance availability, and examines whether there is a systematic difference in the breadth of insurance coverage in the market that corresponds to the proportion of minority residents in a state. The market share of dwelling fire insurance polices across states for years 2000 and 2003 is analyzed, and evidence is presented that shows a positive correlation between the proportion of minority homeowners in a state and the share of more restrictive dwelling fire policies. However, this difference is not statistically significant once other risk-related and economic factors are included in the analysis.     

Providers’ affiliation,insurance and collusion

This paper provides a theoretical analysis of the benefits for an insurance company to develop its own network of service providers when insurance fraud is characterized by collusion between policyholders and providers. In a static framework without collusion, exclusive affiliation of providers allows insurance companies to recover some market power and to lessen competition on the insurance market. This entails a decrease in the insured’s welfare. However, exclusive affiliation of providers may entail a positive effect on customers’ surplus when insurers and providers are engaged in a repeated relationship. In particular, while insurers must cooperate to retaliate against a fraudulent provider under non-exclusive affiliation, no cooperation is needed under exclusive affiliation. In that case, an insurer is indeed able to reduce the profit of a malevolent provider by moving to collusion-proof contracts when collusion is detected, and this threat may act as a deterrent for fraudulent activities. This possibility may supplement an inefficient judicial system: it is thus a second-best optimal anti-fraud policy.     

Market structure and the efficiency of European insurance companies: A stochastic frontier analysis

This paper is motivated by the progressive liberalisation of the European insurance market in recent years. It uses stochastic frontier analysis to estimate Flexible Fourier cost functions for European insurance companies. Separate frontiers are estimated for life, non-life and composite companies. We adopt a maximum likelihood approach to estimation in which the variance of both one-sided and two-sided error terms is modelled jointly with the frontiers. This approach allows us to simultaneously control for the impact of heteroskedasticity on the estimation of scale economies as well as estimating the effect of firm size and market structure on X-inefficiency. The study draws on Standard & Poor’s Eurothesys data set of financial reports for the period 1995 to 2001. This provides technical and non-technical accounts at year-end for life, non-life and composite insurance businesses in 14 major European countries. Our estimates suggest that over this period most European insurers were operating under conditions of decreasing costs (increasing returns to scale), and that company size and domestic market share were significant factors determining X-inefficiency. Larger firms, and those with high market shares, tend to have higher levels of cost inefficiency.     

“Crises” in medical malpractice insurance: Evidence of excessive price-cutting in the preceding soft market

Prior work suggests that heterogeneous information or weak incentives for solvency could have caused some general liability insurers to charge low ex ante prices during the early 1980s and mid-to-late 1990s, putting downward pressure on other firms’ prices and plausibly aggravating subsequent periods of rapid premium growth. We analyse whether the 1994–1999 “soft” market in medical malpractice insurance led some firms to underprice, grow rapidly, and subsequently experience upward revisions in loss forecasts (“loss development”), which could have aggravated subsequent market “crises”. Consistent with the underpricing hypothesis, the results indicate a positive relation between loss development and premium growth among growing firms. Underpricing was likely more prevalent among non-specialist malpractice insurers.     

The Capital Structure of Firms Subject to Price Regulation: Evidence from the Insurance Industry

Automobile and workers' compensation insurance are relatively homogeneous products sold under varying regulatory systems among the states. This paper investigates how price regulation affects the capital structure decisions of profit-maximizing insurers who sell insurance in both competitive and/or regulated markets. Specifically, we test the hypothesis that insurers subject to price regulation will choose to hold less capital. In addition, we hypothesize insurers subject to more stringent regulatory pricing constraints will choose even higher degrees of leverage because the benefits of holding additional amounts of capital are suppressed. We conduct empirical tests using cross-sectional data on insurers and find evidence consistent with both hypotheses. These findings have important implications for insurance price and solvency regulation. Stricter price regulation increases the default risk (i.e., reduces the financial quality) of insurance contracts purchased by individuals and firms.     

Health Care Reform,Efficiency of Health Insurers,and Optimal Health Insurance Markets

This research examines the efficiency of the U.S. health insurers. It shows that more insurers are less efficient than in the previous sample year; however, the results suggest that the federal health care reform has no significant effect on the overall efficiency of all insurers as a whole, which is very low but does not change much over time. This research explores how to improve the efficiency of the health insurance market by proposing state, regional, and national efficiency-based goal-oriented market models and an efficiency duplicating system, and it discusses important implications to the health care compacts, the health insurance exchanges or marketplaces, and the national multistate programs. It also analyzes further moves for efficiency enhancement with regard to payment methods and the health care delivery system. One interesting finding is that the Medicaid program is very efficient because it provides support to the offering of Medicaid coverage and further expansion, which enhances the health welfare of society with fewer resources inputs from the perspective of efficiency. This research should provide important insights for state and federal governments, policy makers, regulators, the health insurance industry, and consumers.     

Adaptation and change in the Australian life insurance industry: an historical perspective

In the wake of the deregulation of the financial sector in Australia in the 1980s and 1990s the life insurance industry has undergone a period of rapid change and reorganisation. Part of this adjustment has been the move towards the integration of financial service provision and the rise of bancassurance. This paper investigates the strategies adopted by Australian life insurers as they moved into the increasingly competitive environment triggered by the lifting of government restrictions on banking practices. It compares the approach of life insurers with that adopted in an earlier period of expansion and change. During the 1950s and 1960s an influx of foreign owned insurance companies into the Australian market precipitated the diversification of domestic life insurers into other insurance markets. The catalyst for change in both cases was the change in information costs brought about by the change in the competitive environment. The experience of the Australian life insurance market would suggest that there is a link between changing information costs and changing organisational structures. However this link is circumscribed by the institutional environment.     

Economies of scope in financial services: A DEA efficiency analysis of the US insurance industry

This paper investigates economies of scope in the US insurance industry over the period 1993–2006. We test the conglomeration hypothesis, which holds that firms can optimize by diversifying across businesses, versus the strategic focus hypothesis, which holds that firms optimize by focusing on core businesses. We analyze whether it is advantageous for insurers to offer both life-health and property-liability insurance or to specialize in one major industry segment. We estimate cost, revenue, and profit efficiency utilizing data envelopment analysis (DEA) and test for scope economies by regressing efficiency scores on control variables and an indicator for strategic focus. Property-liability insurers realize cost scope economies, but they are more than offset by revenue scope diseconomies. Life-health insurers realize both cost and revenue scope diseconomies. Hence, strategic focus is superior to conglomeration in the insurance industry.     

Determinants of International Insurers' Participation in Foreign Non-Life Markets

Mirroring the trend in the broader marketplace, the global insurance industry is steadily moving toward increased liberalization and deregulation. This study seeks to develop the first empirical model that examines the importance of foreign market characteristics as they relate to the participation of international insurers in the non‐life business of those countries. The analysis reveals that market structure is an important factor in determining whether international insurers participate in a given foreign market. In addition, for markets that are not competitive, removing trade barriers would significantly improve the desirability of those countries as host markets. The results also suggest that countries with higher gross domestic product tend to attract more involvement from international insurers. While this research focuses on the markets of industrialized countries, the findings will provide significant implications for those emerging markets that have not yet collected relevant data on a number of the variables included in this study.     

Equilibrium Pricing of General Insurance Policies

Abstract

A model is developed for determining the price of general insurance policies in a competitive, noncooperative market. This model extends previous single-optimizer pricing models by supposing that each participant chooses an optimal pricing strategy. Specifically, prices are determined by finding a Nash equilibrium of an N-player differential game. In the game, a demand law describes the relationship between policy sales and premium, and each insurer aims to maximize its (expected) utility of wealth at the end of the planning horizon. Two features of the model are investigated in detail: the effect of limited total demand for policies, and the uncertainty in the calculation of the breakeven (or cost price) of an insurance policy.

It is found that if the demand for policies is unlimited, then the equilibrium pricing strategy is identical for all insurers, and it can be found analytically for particular model parameterizations. However, if the demand for policies is limited, then, for entrants to a new line of business, there are additional asymmetric Nash equilibria with insurers alternating between maximal and minimal selling. Consequently it is proposed that the actuarial cycle is a result of price competition, limited demand, and entry of new insurers into the market. If the breakeven premium is highly volatile, then the symmetric equilibrium premium loading tends to a constant, and it is suggested that this will dampen the oscillatory pricing of new entrants.     

Capital-based regulation,portfolio risk and capital determination: Empirical evidence from the US property–liability insurers

This paper examines the impact of capital-based regulation on the insurer’s risk and capital adjustments in the US property–liability insurance industry. We conduct the three-stage least squares (3SLS) procedure to estimate a simultaneous equations model. The key finding is that undercapitalized insurers increase capital to avoid regulatory costs and take more risks to generate higher returns. We also investigate firm characteristics that determine the insurer’s capital structure. The results indicate that insurers appear to rely heavily on retained earnings to make up their capital shortage and insurers with greater growth opportunity may hold high levels of capital to control for agency problems. Robustness tests with an alternative risk measure and subsamples present consistent results.     

RELATIVE EFFICIENCIES OF NON-LIFE REINSURANCE MARKETING METHODS

Abstract: This paper extends the study of the relative cost efficiency of insurance delivery systems from the primary market to the market for non-life reinsurance services. As in the primary market for insurance services there are two predominant methods of marketing reinsurance services: reinsurers who rely on employees, termed direct writers, and those who rely on brokers.
An extensive literature relating to the primary market for non-life insurance consistently indicates that independent agency insurers have a cost disadvantage relative to exclusive agency insurers. This literature also suggests that independent agency insurers may supply superior service but a continuing erosion of the market share of independent agency insurers suggests that the perceived service differential is not valued sufficiently to offset the perceived cost differential.
The authors find evidence that, cet. par., broker supplied reinsurers operate with lower costs than direct reinsurers but we find less convincing evidence of a service differential favoring direct reinsurers. More significantly, we observe that the largest component of the traditional measure of the reinsurer's cost is the commission paid back to the primary insurer: the seemingly lower cost brokers provide a higher net cost product. Yet brokers thrive in the marketplace suggesting the existence of a product differentiated by service or quality. With the important caveat that measures of service are imperfect and data is limited, we find no evidence of a service differential.     

Is Historical Cost Accounting a Panacea? Market Stress,Incentive Distortions,and Gains Trading

Accounting rules, through their interactions with capital regulations, affect financial institutions’ trading behavior. The insurance industry provides a laboratory to explore these interactions: life insurers have greater flexibility than property and casualty insurers to hold speculative‐grade assets at historical cost, and the degree to which life insurers recognize market values differs across U.S. states. During the financial crisis, insurers facing a lesser degree of market value recognition are less likely to sell downgraded asset‐backed securities. To improve their capital positions, these insurers disproportionately resort to gains trading, selectively selling otherwise unrelated bonds with high unrealized gains, transmitting shocks across markets.     

Effizienz und Eigentümerstruktur: Eine empirische Analyse des deutschen Lebensversicherungsmarktes

We provide new insights into the effect of ownership on efficiency by analyzing the German life insurance market over the period 2002–2005. Previous research on alternative organizational forms in the life insurance industry has focused on stock and mutual ownership only. Due to the uniqueness of the German insurance market, where privately-owned companies face competition by public insurers, we add to the recent literature the well known debate on public versus private ownership, by investigating stock, mutual and public ownership forms. Using traditional DEA, we calculate technical efficiency and cost efficiency scores to test the efficient structure hypothesis as well as the expense preference hypothesis. Our results give strong support to the latter, while we find no evidence that public ownership is an efficient corporate structure for life insurers. The group of stock firms dominates both, mutual and public insurers, although differences between stock and mutual companies are smaller than differences between stock and public firms. Analyzing within-group results, our findings suggest that high efficiency scores can be associated with certain firm characteristics which are publicly available: high returns on assets, low cancellation rates and low costs.     

The effects of reform on China’s bank structure and performance

This paper investigates the relationship between market structure and performance in China’s banking system from 1985 to 2002, a period when this sector was subject to gradual but notable reform. Using panel data estimation techniques, both the market-power and efficient-structure hypotheses are tested. In addition, the model is extended to consider issues such as the impact of bank size/ownership and whether the big four banks enjoy a “quiet life”. On average, X-efficiency declined significantly and most banks were operating below scale efficient levels. Estimation of the structure–performance models lends some support to the relative market-power hypothesis in the early period. The reforms had little impact on the structure of China’s banking sector, though the “joint stock” banks became relatively more X-efficient. There was no evidence to support the quiet-life hypothesis, probably because strict interest rate controls prevented the state banks from earning monopoly profits. Thus the ongoing liberalisation of interest rates should be accompanied by reduced concentration. Overall, to improve competitive structure, new policies should be directed at encouraging market entry and increasing the market share of the most efficient banks.     

Why haven’t U.S. GAAP and IFRS on insurance contracts converged? Evidence from an unsuccessful joint project

This study examines the FASB’s and IASB’s unsuccessful joint project on accounting for insurance contracts. It highlights the divergent views the Boards may hold on certain fundamental accounting issues. Further, this study examines how the costs and benefits of accounting standard convergence can vary within an industry, conditional on factors such as prior accounting standards and firms’ global operations. Empirically, U.S. insurers’ negative market reactions to the joint insurance project suggest U.S. investors perceived net costs would outweigh net benefits. This study also finds that market reactions of U.S. insurers were more negative than those of European insurers. The results of cross-sectional analyses indicate that U.S. life insurers perceived higher net costs associated with the joint project, while European insurers with more global revenue perceived higher net benefits. This work illuminates some of the challenges facing standard setters when attempting to develop a globally acceptable set of financial reporting standards.     

Deregulation,Pricing Strategies,and Claim Behavior in the Taiwan Automobile Insurance Market

Stringent pricing regulations have long been in effect in the Taiwan automobile insurance market. In April 2009, a pricing deregulation was adopted, enabling insurers to establish their own auto insurance premium rates. This study examines the effects of deregulation in terms of three hypotheses that we propose pertaining to market shares, loading factors, and last policy month claims. The quantitative analysis results show that pricing deregulation prompts insurers to lower their rates. The effects of deregulation for insurers are determined by not only the decision to deduct premiums and the deduction percentages, but also by policy type.