The Relationship Between Regulatory Pressure and Insurer Risk Taking

Abstract

The article examines the risk-taking behavior of property-liability insurers in the presence of risk-based capital regulation. An option pricing model is developed to evaluate the expected regulatory cost and predict a nonlinear relationship between regulatory pressure and insurers' risk taking. We then conduct an empirical test using the simultaneous threshold regression. The result shows that there is a threshold effect of regulatory pressure on insurer risk taking. Poorly capitalized insurers seem to be aware of their proximity to regulatory interventions but do not fully respond to the impending regulatory pressure. This implies either regulatory interventions are not costly enough or they are too late, or both.

Regulations, profitability, and risk-adjusted returns of European insurers: An empirical investigation

“…Similarly, in one of the few studies that focuses on profitability rather than risk, Born (2001) shows that no significant relationship exists between capital requirements and return on equity across U.S. states with different regulatory environments. 8 Lin et al (2013) provide a potential explanation for these mixed findings. They build an option pricing model that predicts a nonlinear relationship between regulatory pressure, in terms of risk-based capital standards, and insurers' risk-taking.…”

Investment Activity of Insurers and the State Economic Growth

“…Thus, W-Ch. Lin et al (2014) in their study show that there is a threshold effect of the state interference in the investment policy of the insurer. The conclusion is drawn that often, strict regulation by the state has the opposite effect for the economy.…”

Analyst coverage, executive compensation and corporate risk‐taking: Evidence from property–casualty insurance firms

“…Following prior literature, we identify important determinants of firm risk, to reduce the heterogeneity in corporate risk profiles (Cheng & Weiss, 2012; Ellul et al, 2011; Lin et al, 2014). These include firm size, leverage ratio, business concentration, geographic concentration, the share of long‐tail business, the growth in direct premiums written, and the share of reinsurance in the gross premium written (Appendix ).…”