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Price Regulation, Market Exit, and Financial Leverage of Canadian Property-Liability Insurers

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Author Info
Strauss, Jason

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Abstract

This paper investigates strategic brinksmanship between regulated property-liability insurance firms and their regulators. Prior research suggests that firms increase their financial leverage, and thus their probability of bankruptcy and expected bankruptcy costs, in order to mitigate the severity of binding price ceilings. Although financial leverage can be altered by changing capital structure, it can also be altered by increasing other liabilities, as analyzed in this paper. This paper uses an instrumental variable for price regulation with a maximum-likelihood Heckman estimation method over panel data for Canadian property-liability insurers to extract the impact that price regulation has on the financial leverage of insurers as well as the probability of bankruptcy, the non-selection probability.

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Publisher Info
Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 11212.

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Date of creation: 26 Dec 2007
Date of revision: 28 Oct 2008
Handle: RePEc:pra:mprapa:11212

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Related research
Keywords: Price Regulation; Insurance; Financial Leverage; Capital Structure; Bankruptcy;

Find related papers by JEL classification:
G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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References listed on IDEAS
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  1. Cummins, J David & Mahul, Olivier, 2003. " Optimal Insurance with Divergent Beliefs about Insurer Total Default Risk," Journal of Risk and Uncertainty, Springer, vol. 27(2), pages 121-38, October. [Downloadable!] (restricted)
  2. Harrington, Scott E & Danzon, Patricia M, 1994. "Price Cutting in Liability Insurance Markets," Journal of Business, University of Chicago Press, vol. 67(4), pages 511-38, October. [Downloadable!] (restricted)
  3. Winter Ralph A., 1994. "The Dynamics of Competitive Insurance Markets," Journal of Financial Intermediation, Elsevier, vol. 3(4), pages 379-415, September. [Downloadable!] (restricted)
  4. Cagle, Julie A B & Harrington, Scott E, 1995. "Insurance Supply with Capacity Constraints and Endogenous Insolvency Risk," Journal of Risk and Uncertainty, Springer, vol. 11(3), pages 219-32, December.
  5. Robert Klein & Richard Phillips & Wenyan Shiu, 2002. "The Capital Structure of Firms Subject to Price Regulation: Evidence from the Insurance Industry," Journal of Financial Services Research, Springer, vol. 21(1), pages 79-100, February. [Downloadable!] (restricted)
  6. Doherty, Neil A & Schlesinger, Harris, 1990. "Rational Insurance Purchasing: Consideration of Contract Nonperformance," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 243-53, February. [Downloadable!] (restricted)
  7. Richard D. Phillips & J. David Cummins & Franklin Allen, 1996. "Financial Pricing of Insurance in the Multiple Line Insurance Company," Center for Financial Institutions Working Papers 96-09, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
  8. Cummins, J. David & Lamm-Tennant, Joan, 1994. "Capital structure and the cost of equity capital in the property-liability insurance industry," Insurance: Mathematics and Economics, Elsevier, vol. 15(2-3), pages 187-201, December. [Downloadable!] (restricted)
  9. Bradley, Michael & Jarrell, Gregg A & Kim, E Han, 1984. " On the Existence of an Optimal Capital Structure: Theory and Evidence," Journal of Finance, American Finance Association, vol. 39(3), pages 857-78, July. [Downloadable!] (restricted)
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  12. Paul L. Joskow, 1973. "Cartels, Competition and Regulation in the Property-Liability Insurance Industry," Bell Journal of Economics, The RAND Corporation, vol. 4(2), pages 375-427, Autumn. [Downloadable!] (restricted)
  13. Taggart, Robert A, Jr, 1981. "Rate-of-Return Regulation and Utility Capital Structure Decisions," Journal of Finance, American Finance Association, vol. 36(2), pages 383-93, May. [Downloadable!] (restricted)
  14. Robert L. Hagerman & Brian T. Ratchford, 1978. "Some Determinants of Allowed Rates of Return on Equity to Electric Utilities," Bell Journal of Economics, The RAND Corporation, vol. 9(1), pages 46-55, Spring. [Downloadable!] (restricted)
  15. Barros, Pedro P, 1996. "Competition Effects of Price Liberalization in Insurance," Journal of Industrial Economics, Blackwell Publishing, vol. 44(3), pages 267-87, September. [Downloadable!] (restricted)
  16. Joong, K.W. & mayers, D. & Smith, C.V., 1996. "On the Choice of Insurance Distribution Systems," The A. Gary Anderson Graduate School of Management 96-15, The A. Gary Anderson Graduate School of Management. University of California Riverside.
  17. Harrington, Scott E, 1987. "A Note on the Impact of Auto Insurance Rate Regulation," The Review of Economics and Statistics, MIT Press, vol. 69(1), pages 166-70, February. [Downloadable!] (restricted)
  18. Gron, Anne, 1994. "Evidence of Capacity Constraints in Insurance Markets," Journal of Law & Economics, University of Chicago Press, vol. 37(2), pages 349-77, October.
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