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The Causes and Consequences of Rate Regulation in the Auto Insurance Industry

In: The Economics of Property-Casualty Insurance

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  • Dwight Jaffee
  • Thomas Russell

Abstract

This paper examines various explanations for the increase in the degree of regulation of the auto industry in the last ten years. Using cross section data for the State of California, the paper confirms earlier findings for the State of Massachusetts that the demand for auto insurance is highly price elastic. This implies that regulation induced price rollbacks (such as those mandated by California's popular initiative Proposition 103) have significant welfare effects. We explain the increase in regulation in two ways: a) As an attempt to lower rates to deal with the problem of the uninsured motorist. b) More fundamentally as a response to the perceived lack of fairness of the sharp increase in premiums in the 1980s. This perception of lack of fairness arises because, although auto insurance costs rose sharply in the 1980s, most buyers of auto insurance have no claims in any ten year period. Thus most buyers have only last year's premium as a reference point with which to judge the fairness of this year's premium. The hypothesis that the increase in regulation is driven by a perception of unfairness is tested by analyzing the cross county voting pattern on Proposition 103. Voting in favor of price regulation is positively correlated with the level of insurance premium. This result is consistent both with the view that voting behavior is based on self interest and with the view that the increased demand for regulation is driven by concerns that the large disparity in premiums across counties is unfair.

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This chapter was published in:

  • David F. Bradford, 1998. "The Economics of Property-Casualty Insurance," NBER Books, National Bureau of Economic Research, Inc, number brad98-1, May.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 6939.

    Handle: RePEc:nbr:nberch:6939

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    1. Smith, Eric & Wright, Randall, 1992. "Why Is Automobile Insurance in Philadelphia So Damn Expensive?," American Economic Review, American Economic Association, vol. 82(4), pages 756-72, September.
    2. Rubinstein, Ariel & Yaari, Menahem E., 1983. "Repeated insurance contracts and moral hazard," Journal of Economic Theory, Elsevier, vol. 30(1), pages 74-97, June.
    3. Malinvaud, E., 1972. "The allocation of individual risks in large markets," Journal of Economic Theory, Elsevier, vol. 4(2), pages 312-328, April.
    4. Borenstein, Severin, 1989. "The economics of costly risk sorting in competitive insurance markets," International Review of Law and Economics, Elsevier, vol. 9(1), pages 25-39, June.
    5. Hoy, Michael, 1982. "Categorizing Risks in the Insurance Industry," The Quarterly Journal of Economics, MIT Press, vol. 97(2), pages 321-36, May.
    6. Hoy, Michael, 1989. "The value of screening mechanisms under alternative insurance possibilities," Journal of Public Economics, Elsevier, vol. 39(2), pages 177-206, July.
    7. Spence, A Michael, 1973. "Job Market Signaling," The Quarterly Journal of Economics, MIT Press, vol. 87(3), pages 355-74, August.
    8. Dionne, G. & Doherty, N. & Fombaron, N., 2000. "Adverse Selection in Insurance Markets," Ecole des Hautes Etudes Commerciales de Montreal- 00-05, Ecole des Hautes Etudes Commerciales de Montreal-Chaire de gestion des risques..
    9. D'Arcy, Stephen P & Doherty, Neil A, 1990. "Adverse Selection, Private Information, and Lowballing in Insurance Markets," The Journal of Business, University of Chicago Press, vol. 63(2), pages 145-64, April.
    10. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard, 1986. "Fairness as a Constraint on Profit Seeking: Entitlements in the Market," American Economic Review, American Economic Association, vol. 76(4), pages 728-41, September.
    11. John G. Riley, 1976. "Informational Equilibrium," UCLA Economics Working Papers 071, UCLA Department of Economics.
    12. Boyer, Marcel & Dionne, Georges, 1989. "An Empirical Analysis of Moral Hazard and Experience Rating," The Review of Economics and Statistics, MIT Press, vol. 71(1), pages 128-34, February.
    13. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
    14. Keeton, William R & Kwerel, Evan, 1984. "Externalities in Automobile Insurance and the Underinsured Driver Problem," Journal of Law and Economics, University of Chicago Press, vol. 27(1), pages 149-79, April.
    15. Crocker, Keith J & Snow, Arthur, 1986. "The Efficiency Effects of Categorical Discrimination in the Insurance Industry," Journal of Political Economy, University of Chicago Press, vol. 94(2), pages 321-44, April.
    16. Bond, Eric W & Crocker, Keith J, 1991. "Smoking, Skydiving, and Knitting: The Endogenous Categorization of Risks in Insurance Markets with Asymmetric Information," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 177-200, February.
    17. Blackmon, B Glenn, Jr & Zeckhauser, Richard, 1991. "Mispriced Equity: Regulated Rates for Auto Insurance in Massachusetts," American Economic Review, American Economic Association, vol. 81(2), pages 65-69, May.
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    Cited by:
    1. Dwight M. Jaffee & Thomas Russell, 1996. "Catastrophe Insurance, Capital Markets and Uninsurable Risks," Center for Financial Institutions Working Papers 96-12, Wharton School Center for Financial Institutions, University of Pennsylvania.
    2. Dwight Jaffee, 2006. "Monoline Restrictions, with Applications to Mortgage Insurance and Title Insurance," Review of Industrial Organization, Springer, vol. 28(2), pages 83-108, 03.

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