Emilio C. Venezian

Insurance Markets with Loss-Prevention Activity: Profits, Market Structure, and Consumer Welfare

This article considers the joint production of insurance protection and loss prevention by insurers. We first examine the loss distribution of consumers that is potentially the most profitable for insurers. Unlike in the preponderance of the insurance literature, which assumes cost-based pricing of insurance policies, we allow the insurer to charge whatever price the market will bear. We then examine the expected-profit-maximizing strategy of assumes cost-based pricing of insurance policies, we allow the insurer to charge whatever price the market will bear. We then examine the expected-profit-maximizing strategy of the insurer in several different market settings. Whether the insurance protection and loss-prevention services can be perfectly bundled plays a key roll in the insurers pricing decision. We consider consumer welfare under various market settings and demonstrate that a consumer may be better off when the insurance market is monopolistic rather than competitive. Finally, we consider whether monopoly power in the loss-prevention market leads to monopoly power in an otherwise perfectly contestable insurance market. We also show conditions under which a loss-prevention monopolist would increase expected profit by integrating into the insurance market.

Application of spectral and ARIMA analysis to combined‐ratio patterns

Purpose – This paper seeks to use spectral analysis as an alternative method to analyze whether underwriting results exhibit a cyclical behavior for the property-liability insurance industry and by lines of business. In addition, aims to use the AR(2) process to obtain information about cyclical behavior and cycle lengths. Then, the results from the two methods are to be closely examined and compared. Design/methodology/approach – Spectral analysis and ARIMA are used to obtain cycle lengths, then to compare them to check the consistency of the two methods. Findings – The AR(2) produced more significant results than spectral analysis. Originality/value – This is the first article in insurance using significant levels for spectral analysis to decide appropriate cycle lengths. In addition, the consideration of multiple comparisons to get critical values for significance levels reduces false positive and produces more reliable results.

The use of spectral analysis in insurance cycle research

Purpose – Aims to address a number of issues related to the use of spectral analysis in the study of insurance cycles. Design/methodology/approach – Spectral analysis has seldom been used in the study of insurance cycles. This may be due to the fact that no statistical test is readily available for rejecting the hypothesis that a spectrum is significantly different from random uncorrelated noise in a context in which the period of the alternative is not known. This article suggests one such test. Findings – In evaluating the proposed test, the relevant critical points, when the number of observations is small, and provided the power of the test is also explored to identify three cyclical processes: a sine process with noise, a second-order autoregressive process, and the rational expectations process suggested by Cummins and Outreville. Originality/value – The article provides the first comprehensive analysis and discussion of spectral analysis in the context of insurance-cycle research.

A “square‐root rule” for reinsurance? Evidence from several national markets

Purpose – Using a game-theoretic model of insurance markets, Powers and Shubik in 2001 derived a mathematical expression for the optimal number of reinsurers for a given number of primary insurers. Subsequently in 2005, Powers and Shubik showed analytically that, for large numbers of primary insurers, this expression is effectively a “square-root rule”, i.e. the optimal number of reinsurers in a market is given asymptotically by the square root of the total number of primary insurers. In this paper, we test the accuracy of the square-root rule empirically. Design/methodology/approach – The numbers of primary insurers and reinsurers existing in a range of 18-20 different national insurance markets over a period of 11 years are used. Findings – The empirical results are consistent with the square-root rule. In addition, we find that the number of reinsurers may also be associated with the markets willingness to pay for risk. When the markets perception of risk is high, there is a greater supply of reinsurance to provide capacity to primary insurers. Originality/value – An empirical model is presented that deals explicitly with the number of insurers and reinsurers in a market. This is of value to government policymakers and insurance regulators.

Of happy and hapless regulators: the asymptotics of ruin

Abstract We employ a simple single-period ruin probability as a useful tool for studying various asymptotic effects associated with increasing the number of exposure units, n , covered by an insurer. These effects include: the law of large numbers, the roles of capital and underwriting profit loadings, and adverse selection. For a model with known parameters, we find the necessary and sufficient condition for the ruin probability to converge to zero, as well as sufficient conditions for the normal approximation to provide asymptotically accurate comparative statics with respect to n . For a model with parameter-estimation errors, we find that the normal approximation no longer holds in general, and that the necessary and sufficient condition for the ruin probability to approach zero becomes much more restrictive.

Ex ante loss control by insurers: Public interest for higher profit

This article examines the incentives of an insurer to modify loss distributions prior to the sale of insurance. While actions such as lobbying Congress for mandatory airbags in automobiles are undertaken by insurers for the stated purpose of reducing the aggregate loss in society, they also change the nature of the risk being insured and, hence, affect the profitability of insurance sales. For the case of loss prevention (reducing the probabilty of a loss), insurers do not always have an incentive to invest in loss control. For loss reduction (reducing the severity of any loss that does occur), the incentive is to reduce the size of small losses while simultaneously increasing the size of large losses.

Reciprocal insurance: a case of supply created by demand

Purpose – The purpose of this study is to determine the characteristics of the equilibrium between demand and supply for a reciprocal insurance firm. Design/methodology/approach – The model developed assumes a fixed number of individuals with identical characteristics and of constant absolute risk aversion who can choose between remaining self-insured or forming a reciprocal insurer to serve their needs. Findings – The results show that under those conditions the individuals either remain self-insured or form a reciprocal and buy full insurance. Which of the two decisions will be made depends on the relation between the number of members of the reciprocal and the expenses that will be incurred by that entity. Research limitations/implications – Most alternative models of insurance demand imply that, in the presence of transaction costs, partial insurance is the rule. Practical implications – The major practical implication is that there can be serious agency problems in the management of reciprocals if attorneys-in-fact have influence over their salaries, since they may be able to increase their private welfare at the expense of that of the policyholders. Originality/value – The model is new and its practical implications have not been discussed previously.

Compensating Victims of Occupational Diseases: Can We Structure an Effective Policy?

Workers afflicted with occupational injury or disease are compensated for their losses in a variety of ways. The mechanism that is most often considered is workers’ compensation insurance which, under suitable conditions, provides compensation for such losses without regard to fault on the part of the employer. Workers may also be compensated through the existence of wage differentials related to the anticipated losses or to the portion of those losses not properly compensated from other sources. In addition, victims of occupational injury or disease may obtain compensation through the tort system if the cause of injury or disease is a product whose producer has failed to provide it in a safe form or with suitable warnings regarding the dangers involved in its use. Other sources of compensation include private disability insurance, private health and accident insurance, and payments under public programs such as Social Security. This paper discusses the problems associated with structuring a reasonable system of compensation for occupational disease in a context in which various sources of compensation exist.1

Incentive incompatibilities and arbitrage opportunities

Purpose - The paper aims to examine the practical importance of the finding of Mayers and Smith, that underinvestment is a problem when debt exposed to bankruptcy is part of the financial structure. Design/methodology/approach - The paper examines critically the assumptions underlying the Mayers and Smith paper. Findings - The necessary assumption of deterministic arbitrage in the market for productive properties used by Mayers and Smith in their model is found to be unrealistic. Even if that assumption were valid, however, the result of Mayers and Smith establishes that raising exposed debt is a negative net present value project for the investor and hence that form of financing would not be found in practice. Practical implications - The existence of exposed debt does not explain the demand or commercial insurance. Originality/value - The paper challenges the results of Mayers and Smith that have been used to examine the effect of debt on insurance demand for almost 20 years with mixed results.