Sharon Tennyson

Consolidation and efficiency in the US life insurance industry

This paper examines the relationship between mergers and acquisitions, efficiency, and scale economies in the U.S. life insurance industry. We estimate cost and revenue efficiency over the period 1988-1995 using data envelopment analysis (DEA). The Malmquist methodology is used to measure changes in efficiency over time. We find that acquired firms achieve greater efficiency gains than firms that have not been involved in mergers or acquisitions. Firms operating with nondecreasing returns to scale and financially vulnerable firms are more likely to be acquisition targets. Overall, mergers and acquisitions in the life insurance industry have had a beneficial effect on efficiency.

Moral Hazard in Insurance Claiming: Evidence from Automobile Insurance

This article provides new evidence on moral hazard in insurance markets by analyzing the frequency of automobile bodily injury liability (BIL) claims. We conduct cross-sectional regressions of statewide BIL claims frequency rates on variables representing state economic, demographic, and legal characteristics that affect the marginal costs and benefits of filing claims. As an indicator of moral hazard, we use survey data on consumer attitudes toward various types of dishonest behavior relating to insurance claims. The results provide strong support for the hypothesis that attitudes toward dishonest behavior are related to BIL claims frequency, and thus provide evidence of significant moral hazard in automobile insurance markets.

Reinsurance and the liability insurance crisis

Insurance-industry accounts of the liability insurance crisis of the mid-1980s often cite disruption of supply in reinsurance markets as an important contributing factor. Economic theories of the crisis have not explored this explanation for the severity of the crisis. This article investigates the extent to which events in reinsurance markets affected liability insurance market outcomes. It documents significant shocks to reinsurance supply in the early 1980s and finds evidence of subsequent disruptions to the price and availability of reinsurance. Regression analysis of liability insurance profitability over the time period supports the hypothesis that problems in reinsurance markets played an important role in the crisis.

Insurance Fraud and Optimal Claims Settlement Strategies

We examine the optimal claims settlement strategy for a liability insurer when claimants can permanently misrepresent their losses by engaging in costly claims falsification. In this environment, claims auditing is not a possible deterrent to fraud, and the settlement strategy consists of an indemnification profile that relates the insurance payment to the claimed amount of loss. The optimal indemnification profile is shown to involve systematic underpayment of claims at the margin as a means to deter loss exaggeration, with the extent of underpayment limited by expected litigation costs and potential bad‐faith claims. The key testable implication of the theory is that the extent of underpayment should be greater for classes of claims for which loss exaggeration is easier. Empirical analysis of insurance settlements for bodily injury liability in automobile accidents confirms this prediction. This suggests that liability insurers optimally choose claims payment strategies to lessen a claimants incentive to exaggerate losses.

Agent Discretion and the Choice of Insurance Marketing System

This article argues that different insurance marketing organizations arise as a means to minimize the costs of correctly matching policyholder risks with insurance coverage. When policyholders are easily sorted without sales agent participation in screening, exclusive dealing will be the preferred marketing organization; when agent information is important for risk placement, independent agency may be preferred. Empirical support for our theory is obtained from analysis of compensation contracts and market shares of the different marketing forms. Exclusive dealers are found to be prevalent in relatively standardized, homogeneous product lines and markets, and their agents receive less profit-based compensation than those of independent agency insurers. These findings are consistent with our theory.

Capital Shocks and Merger Activity in the Property-Liability Insurance Industry

Ths article investigates the prevalence of financial synergies as a motive for merger and acquisition activity in the property-liability insurnce industry. Two hypotheses are developed and tested based upon theories of information asymmetries and firm financing decisions (Myers and Majluf 1984): (1) that financial synergies are a primary motive for insurance mergers in general and (2) that mergers motivated by financial synergies wiU be more prevalent in periods following negative industry capital shocks. The hypotheses are tested via analysis of accounting ratios of acquisitions targets in the period 1980 through 1990 in relation to those of non-acquired firms of similar characteristics, and via analysis of acquisition characteristics. The hypothesis that financial synergies are a motive for mergers following negative industry capital shocks receives strong support.

Insurance Distribution Systems

This chapter details the use of different insurance distribution systems in practice, analyzes key issues in distribution system use based on economic theories of the organization of the firm, and discusses public policy and regulatory issues related to insurance distribution. The chapter focuses on what we believe to be the three major economic issues in insurance distribution: the choice of distribution system(s) by an insurer; the nature of insurer-agent relationships, including compensation structure and resale price maintenance; and regulatory oversight of insurance distribution activities, including regulation of entry and of information disclosure to consumers.

The Effects of Regulated Premium Subsidies on Insurance Costs: An Empirical Analysis of Automobile Insurance

State regulation of rates is sometimes used as a means to make automobile insurance more affordable to consumers by restricting insurer profits and pricing practices. Incentive distortions arising from this type of rate regulation might lead to higher accident rates and higher insurance loss costs. Annual state-level panel data for the time period 1980–1998 are used to investigate these effects, using empirical methods that recognize the endogenous determination of states’ regulatory choices. Results suggest that rate regulation that systematically suppresses (some or all) drivers’ insurance premiums is associated with significantly higher average loss costs and higher insurance claim frequency.

Costly State Falsification or Verification? Theory and Evidence from Bodily Injury Liability Claims

The impact of private information on insurance markets has long been appreciated by both economists and practitioners. Spurred by the initial presentation of the problem contained in Akerlof’s (1970) examination of the market for lemons, analyses of environments in which insureds possessed asymmetric information about their likelihood of suffering insurable losses have addressed the issues of adverse selection (Rothschild and Stiglitz, 1976) and moral hazard (Shavell, 1979). More recently, the burgeoning problems associated with fraud in insurance claiming have led economists to consider an alternative form of informational asymmetry in which the private information held by the insured individuals involved the actual magnitude of an economic loss. The resulting analyses may be dichotomized into two distinct lines of inquiry, which are known in the literature as the problems of costly state verification and falsification, respectively.

The coexistence of distribution systems under price search: Theory and some evidence from insurance

Abstract This paper analyzes a pure price search model of an insurance market in which two different search technologies are simultaneously available: sequential search and nonsequential search. Sequential search characterizes firms that sell directly to consumers and nonsequential search characterizes firms who use independent agents that sell the products of a number of different firms. The separation of firms and consumers into the two market sectors is endogenously determined, and the conditions for equilibrium coexistence are derived. The characteristics of price distributions in the two sectors are then compared in a coexistence equilibrium. Price distributions observed in automobile insurance markets are found to be consistent with the predictions of the theoretical model.