Incentive Effects of Community Rating in Insurance Markets: Evidence from Massachusetts Automobile Insurance

Abstract

Rate regulations in insurance markets often impose cross-subsidies in insurance premiums from low-risk consumers to high-risk consumers. This paper develops the hypothesis that premium cross-subsidies affect risk taking by insurance consumers, and tests this hypothesis by examining the marginal impact of premium subsidies and overcharges on future insurance costs. The empirical analysis uses 1990-2003 rating cell-level data from the Massachusetts automobile insurance market, in which regulation produced large cross-subsidies across cells. Consistent with the hypothesized effects, premium subsidies are found to be significantly related to higher future insurance costs, and the opposite effects are found for premium overcharges.

Insurance pricing discrimination and Aristotelian equality: an application to annuity pricing

“…3 Many insurance risk classification systems have been developed and fine-tuned over decades of use, and insurers have accumulated a body of statistical evidence to demonstrate how the pricing variables used to set premiums are correlated to their insureds' expected losses. Setting premiums based on an estimate of the insured policyowner's expected loss, a practice known as mean-based or riskbased pricing (Powell, 2020), is economically efficient, as charging insufficient premiums creates incentives for higher-risk policyowners to engage in riskier activities (Harrington & Doerpinghaus, 1993;Tennyson, 2010).…”

“…Insurers are prohibited from using these factors in the pricing of insurance, even if they are correlated to expected losses. While these categories of protected classes are common across the U.S. (Avraham et al, 2014;Stead, 2020), some states' legislatures have extended the list, with common additional categories including prohibitions on gender-or age-based discrimination (Tennyson, 2010). 9. https://content.naic.org/sites/default/files/model-law-gdl-1775-property-casualty-ratinglaw.pdf.…”

“…Because insurance premiums calculations are based on the expected loss of the applicant-the practice commonly known as risk-based pricing (Powell, 2020) -banning the use of essential insurance pricing variables due to discrimination concerns can result in failing to control for differences in insured loss costs between protected and non-protected classes. In turn, this can lead to insurers combining applicants with heterogeneous risk levels into common risk pools, thus potentially resulting in pricing inequities, inefficient insurance pricing (Tennyson, 2010), and adverse selection (Dahlby, 1983).…”

Assessing the Enabling Environment for Disaster Risk Financing: A Country Diagnostics Tool Kit

“…In commercial insurance, regulatory restrictions often impose underwriting restrictions on insurers and limit insurers' ability to charge different insurance premiums to consumers. There is a cross-subsidy in insurance premiums from low-risk consumers to high-risk consumers (Tennyson 2010). By avoiding carve-outs, the enabling environment is enhanced, because insurance can function most effectively when the covered items include the widest possible selection of risks.…”

Investor confidence and life insurance demand: can economic condition limit life insurance business?

“…Existing evidence suggested that consumers' insurance knowledge is insufficient and insurance buying decisions do not conform to economic theories of the insurance utility [1]. On the other hand, empirical and experimental evidence also showed that insurance buying decisions greatly diverged from rational economic behavior (Friedman, 1957;Tennyson, 2010). The literature has exhausted this irrational divergence to find various reasons: 1) people react to gains and losses asymmetrically Investor confidence and life insurance demand 1537…”