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Property-Casualty Insurance Guaranty Funds And Insurer Vulnerability To Misfortune

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    Abstract

    This paper presents evidence that the enactment of insurance guaranty fund statutes induced managers of covered insurers to take actions that shifted risk to the guarantor. The mechanism for risk- shifting was a decrease in reserves. The strongest evidence appears for Commercial Multi-Peril insurance, where the enactment of a guaranty fund is associated with a significant decline in a state's loss ratio. Similar effects appear in Homeowners' coverage, although the evidence is not as strong as for Commercial Multi-Peril coverage. The observed decline in the loss ratio is not explained by other factors such as state regulation, investment yields, or time-related trends. The observed decline is too large to be explained by the level of guaranty fund assessments. A concluding section of the paper discusses a pricing method for guaranty fund coverage that could diminish any rewards arising from understatement of future claims. The design of a pricing system could benefit by applying lessons from bank deposit insurance as well as the insurance industry's experience with pricing methods designed to create incentives for loss prevention.

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    Paper provided by Ohio State University in its series Research in Financial Economics with number 9616.

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    Handle: RePEc:wop:ohsrfe:9616

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    1. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
    2. Doherty, Neil A & Garven, James R, 1995. "Insurance Cycles: Interest Rates and the Capacity Constraint Model," The Journal of Business, University of Chicago Press, vol. 68(3), pages 383-404, July.
    3. James Bohn & Brian J. Hall, 1995. "Property and Casualty Solvency Funds as a Tax and Social Insurance System," NBER Working Papers 5206, National Bureau of Economic Research, Inc.
    4. Fama, Eugene F., 1984. "Term premiums in bond returns," Journal of Financial Economics, Elsevier, vol. 13(4), pages 529-546, December.
    5. Thomas F. Cargill & Thomas Mayer, 1992. "U.S. Deposit Insurance Reform," Contemporary Economic Policy, Western Economic Association International, vol. 10(3), pages 95-103, 07.
    6. Patricia Munch & Dennis E. Smallwood, 1980. "Solvency Regulation in the Property-Liability Insurance Industry: Empirical Evidence," Bell Journal of Economics, The RAND Corporation, vol. 11(1), pages 261-279, Spring.
    7. Edward J. Kane, 1987. "No Room for Weak Links in the Chain of Deposit Insurance Reform," NBER Working Papers 2317, National Bureau of Economic Research, Inc.
    8. Smith, Michael L, 1989. "Investment Returns and Yields to Holders of Insurance," The Journal of Business, University of Chicago Press, vol. 62(1), pages 81-98, January.
    9. Cummins, J David, 1988. " Risk-Based Premiums for Insurance Guaranty Funds," Journal of Finance, American Finance Association, vol. 43(4), pages 823-39, September.
    10. Andrew C. Harvey, 1990. "The Econometric Analysis of Time Series, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026208189x, December.
    11. Peltzman, Sam, 1970. "Capital Investment in Commercial Banking and Its Relationship to Portfolio Regulation," Journal of Political Economy, University of Chicago Press, vol. 78(1), pages 1-26, Jan.-Feb..
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