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A CONTINGENT CLAIMS ANALYSIS OF THE IMPACT OF RATE REGULATION ON PROPERTY-LIABILITY INSURANCE PRICE LEVELS (OPTIONS, INSURANCE)
Abstract
The purpose of this study is to investigate the impact of rate regulation on property-liability insurance prices. Regulation of the property-liability insurance industry occurs at the state level with some states pursuing active rate regulation while others rely on competition to set rates. The co-existence of regulated and competitively determined prices provides an opportunity to examine, both cross-sectionally and over a time series, the impact that rate regulation has on prices. Parallels between put options and insurance contracts are developed. The Black-Scholes put pricing model is then redefined under appropriate conditions and used to derive theoretically fair premiums for portfolios of homogeneous insurance policies. Fair premiums are estimated using three alternative data bases that represent different levels of analysis. Three aspects of the relative differences between fair and actual prices are used to analyze the impact of rate regulation on general price levels in each of the data bases. The method of analysis is multiple group significance tests using a nonparametric ANOVA procedure. First, the relative is compared to analyze the impact of different types of rate regulation. Second, the relative price differences of homeowners, commercial and automobile lines are compared to analyze general price level differences across lines. In addition, relative price level differences of a set of homeowners sublines are compared to analyze relative price level differences across sublines. Third, the relative price differences of each regulatory category, line and subline are compared to analyze price level differences across years. The empirical results show general price levels to be consistent across regulatory categories with line level data, marginally inconsistent with homeowners subline data and inconsistent across line, sublines and years. The results suggest that rate regulation impacts relative price levels only marginally at best. Since orderly insurance markets exist in the absence of rate regulation, the continued existence of rate regulation efforts at the state level should be seriously questioned by consumers, regulators and the insurance industry.
Subject Area
Finance
Recommended Citation
GRONEWOLLER, PAUL LITTON, "A CONTINGENT CLAIMS ANALYSIS OF THE IMPACT OF RATE REGULATION ON PROPERTY-LIABILITY INSURANCE PRICE LEVELS (OPTIONS, INSURANCE)" (1986). ETD collection for University of Nebraska-Lincoln. AAI8620809.
https://digitalcommons.unl.edu/dissertations/AAI8620809