IDEAS home Printed from https://ideas.repec.org/a/wly/empleg/v17y2020i1p38-70.html
   My bibliography  Save this article

The Cost of Legal Restrictions on Experience Rating

Author

Listed:
  • Levon Barseghyan
  • Francesca Molinari
  • Darcy Steeg Morris
  • Joshua C. Teitelbaum

Abstract

We investigate the cost of legal restrictions on experience rating in auto and home insurance. The cost is an opportunity cost as experience rating can mitigate the problems associated with unobserved heterogeneity in claim risk, including mispriced coverage and resulting demand distortions. We assess this cost through a counterfactual analysis in which we explore how risk predictions, premiums, and demand in home insurance and two lines of auto insurance would respond to unrestricted multiline experience rating. Using claims data from a large sample of households, we first estimate the variance‐covariance matrix of unobserved heterogeneity in claim risk. We then show that conditioning on claims experience leads to material refinements of predicted claim rates. Last, we assess how households’ demand for coverage would respond to multiline experience rating. We find that the demand response would be large.

Suggested Citation

  • Levon Barseghyan & Francesca Molinari & Darcy Steeg Morris & Joshua C. Teitelbaum, 2020. "The Cost of Legal Restrictions on Experience Rating," Journal of Empirical Legal Studies, John Wiley & Sons, vol. 17(1), pages 38-70, March.
    • Handle: RePEc:wly:empleg:v:17:y:2020:i:1:p:38-70
    DOI: 10.1111/jels.12242
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/jels.12242
    Download Restriction: no
    File URL: https://libkey.io/10.1111/jels.12242?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Angers, Jean-François & Desjardins, Denise & Dionne, Georges & Guertin, François, 2006. "Vehicle and Fleet Random Effects in a Model of Insurance Rating for Fleets of Vehicles," ASTIN Bulletin, Cambridge University Press, vol. 36(1), pages 25-77, May.
    2. Thomas Buchmueller & John Dinardo, 2002. "Did Community Rating Induce an Adverse Selection Death Spiral? Evidence from New York, Pennsylvania, and Connecticut," American Economic Review, American Economic Association, vol. 92(1), pages 280-294, March.
    3. Keith J. Crocker & Arthur Snow, 2011. "Multidimensional Screening in Insurance Markets with Adverse Selection," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 78(2), pages 287-307, June.
    4. Englund, Martin & Guillén, Montserrat & Gustafsson, Jim & Nielsen, Lars Hougaard & Nielsen, Jens Perch, 2008. "Multivariate Latent Risk: A Credibility Approach," ASTIN Bulletin, Cambridge University Press, vol. 38(1), pages 137-146, May.
    5. Levon Barseghyan & Francesca Molinari & Ted O'Donoghue & Joshua C. Teitelbaum, 2013. "The Nature of Risk Preferences: Evidence from Insurance Choices," American Economic Review, American Economic Association, vol. 103(6), pages 2499-2529, October.
    6. Pinquet, Jean, 1998. "Designing Optimal Bonus-Malus Systems from Different Types of Claims," ASTIN Bulletin, Cambridge University Press, vol. 28(2), pages 205-220, November.
    7. R. Guy Thomas, 2008. "Loss Coverage as a Public Policy Objective for Risk Classification Schemes," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 75(4), pages 997-1018, December.
    8. R Guy Thomas, 2007. "Some Novel Perspectives on Risk Classification," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 32(1), pages 105-132, January.
    9. Edward Frees, 2003. "Multivariate Credibility for Aggregate Loss Models," North American Actuarial Journal, Taylor & Francis Journals, vol. 7(1), pages 13-37.
    10. Liran Einav & Amy Finkelstein & Mark R. Cullen, 2010. "Estimating Welfare in Insurance Markets Using Variation in Prices," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 125(3), pages 877-921.
    11. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    12. Thomas Dohmen & Armin Falk & David Huffman & Uwe Sunde & Jürgen Schupp & Gert G. Wagner, 2011. "Individual Risk Attitudes: Measurement, Determinants, And Behavioral Consequences," Journal of the European Economic Association, European Economic Association, vol. 9(3), pages 522-550, June.
    13. 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 321-344, April.
    14. Vuong, Quang H, 1989. "Likelihood Ratio Tests for Model Selection and Non-nested Hypotheses," Econometrica, Econometric Society, vol. 57(2), pages 307-333, March.
    15. Desjardins, Denise & Dionne, Georges & Pinquet, Jean, 2001. "Experience Rating Schemes for Fleets of Vehicles," ASTIN Bulletin, Cambridge University Press, vol. 31(1), pages 81-105, May.
    16. Michael Geruso, 2017. "Demand heterogeneity in insurance markets: Implications for equity and efficiency," Quantitative Economics, Econometric Society, vol. 8(3), pages 929-975, November.
    17. Liran Einav & Amy Finkelstein & Iuliana Pascu & Mark R. Cullen, 2012. "How General Are Risk Preferences? Choices under Uncertainty in Different Domains," American Economic Review, American Economic Association, vol. 102(6), pages 2606-2638, October.
    18. Richard A. Derrig & Sharon Tennyson, 2011. "The Impact of Rate Regulation on Claims: Evidence From Massachusetts Automobile Insurance," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 14(2), pages 173-199, September.
    19. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
    20. Georges Dionne & Casey Rothschild, 2014. "Economic Effects of Risk Classification Bans," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 39(2), pages 184-221, September.
    21. Pierre-Andre Chiappori & Bernard Salanie, 2000. "Testing for Asymmetric Information in Insurance Markets," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 56-78, February.
    22. Casey Rothschild, 2011. "The Efficiency of Categorical Discrimination in Insurance Markets," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 78(2), pages 267-285, June.
    23. Linda L. Golden & Patrick L. Brockett & Jing Ai & Bruce Kellison, 2016. "Empirical Evidence on the Use of Credit Scoring for Predicting Insurance Losses with Psycho-social and Biochemical Explanations," North American Actuarial Journal, Taylor & Francis Journals, vol. 20(3), pages 233-251, July.
    24. Alma Cohen & Peter Siegelman, 2010. "Testing for Adverse Selection in Insurance Markets," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 77(1), pages 39-84, March.
    25. Georges Dionne (ed.), 2013. "Handbook of Insurance," Springer Books, Springer, edition 2, number 978-1-4614-0155-1, February.
    26. M. Kate Bundorf & Jonathan Levin & Neale Mahoney, 2012. "Pricing and Welfare in Health Plan Choice," American Economic Review, American Economic Association, vol. 102(7), pages 3214-3248, December.
    27. Katrien Antonio & Emiliano Valdez, 2012. "Statistical concepts of a priori and a posteriori risk classification in insurance," AStA Advances in Statistical Analysis, Springer;German Statistical Society, vol. 96(2), pages 187-224, June.
    28. Mary A. Weiss & Sharon Tennyson & Laureen Regan, 2010. "The Effects of Regulated Premium Subsidies on Insurance Costs: An Empirical Analysis of Automobile Insurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 77(3), pages 597-624, September.
    29. Levon Barseghyan & Jeffrey Prince & Joshua C. Teitelbaum, 2011. "Are Risk Preferences Stable across Contexts? Evidence from Insurance Data," American Economic Review, American Economic Association, vol. 101(2), pages 591-631, April.
    30. Robert B. Barsky & F. Thomas Juster & Miles S. Kimball & Matthew D. Shapiro, 1997. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Study," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(2), pages 537-579.
    31. M. Kate Bundorf & Kosali I. Simon, 2006. "The Effects of Rate Regulation on Demand for Supplemental Health Insurance," American Economic Review, American Economic Association, vol. 96(2), pages 67-71, May.
    32. Michael Hoy, 1982. "Categorizing Risks in the Insurance Industry," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 97(2), pages 321-336.
    33. Ilayperuma Simon, Kosali, 2005. "Adverse selection in health insurance markets? Evidence from state small-group health insurance reforms," Journal of Public Economics, Elsevier, vol. 89(9-10), pages 1865-1877, September.
    34. Jean-Philippe Boucher & Michel Denuit & Montserrat Guillén, 2007. "Risk Classification for Claim Counts," North American Actuarial Journal, Taylor & Francis Journals, vol. 11(4), pages 110-131.
    35. Martin Englund & Jim Gustafsson & Jens Perch Nielsen & Fredrik Thuring, 2009. "Multidimensional Credibility With Time Effects: An Application to Commercial Business Lines," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 76(2), pages 443-453, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Zifeng Zhao & Peng Shi & Xiaoping Feng, 2021. "Knowledge Learning of Insurance Risks Using Dependence Models," INFORMS Journal on Computing, INFORMS, vol. 33(3), pages 1177-1196, July.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Raj Chetty & Amy Finkelstein, 2012. "Social Insurance: Connecting Theory to Data," NBER Working Papers 18433, National Bureau of Economic Research, Inc.
    2. Johannes Spinnewijn, 2017. "Heterogeneity, Demand for Insurance, and Adverse Selection," American Economic Journal: Economic Policy, American Economic Association, vol. 9(1), pages 308-343, February.
    3. Dionne, Georges & Harrington, Scott, 2017. "Insurance and Insurance Markets," Working Papers 17-2, HEC Montreal, Canada Research Chair in Risk Management.
    4. Georges Dionne & Casey Rothschild, 2014. "Economic Effects of Risk Classification Bans," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 39(2), pages 184-221, September.
    5. Johannes G. Jaspersen & Marc A. Ragin & Justin R. Sydnor, 2022. "Predicting insurance demand from risk attitudes," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 89(1), pages 63-96, March.
    6. Nathaniel Hendren & Camille Landais & Johannes Spinnewijn, 2021. "Choice in Insurance Markets: A Pigouvian Approach to Social Insurance Design," Annual Review of Economics, Annual Reviews, vol. 13(1), pages 457-486, August.
    7. Keith Marzilli Ericson & Philipp Kircher & Johannes Spinnewijn & Amanda Starc, 2021. "Inferring Risk Perceptions and Preferences Using Choice from Insurance Menus: Theory and Evidence," The Economic Journal, Royal Economic Society, vol. 131(634), pages 713-744.
    8. Dardanoni, Valentino & Li Donni, Paolo, 2012. "Incentive and selection effects of Medigap insurance on inpatient care," Journal of Health Economics, Elsevier, vol. 31(3), pages 457-470.
    9. Levon Barseghyan & Francesca Molinari & Ted O'Donoghue & Joshua C. Teitelbaum, 2013. "The Nature of Risk Preferences: Evidence from Insurance Choices," American Economic Review, American Economic Association, vol. 103(6), pages 2499-2529, October.
    10. Capatina, Elena, 2020. "Selection in employer sponsored health insurance," Journal of Health Economics, Elsevier, vol. 71(C).
    11. Liran Einav & Amy Finkelstein & Jonathan Levin, 2010. "Beyond Testing: Empirical Models of Insurance Markets," Annual Review of Economics, Annual Reviews, vol. 2(1), pages 311-336, September.
    12. Benjamin L. Collier & Daniel Schwartz & Howard C. Kunreuther & Erwann O. Michel-Kerjan, 2017. "Risk Preferences in Small and Large Stakes: Evidence from Insurance Contract Decisions," NBER Working Papers 23579, National Bureau of Economic Research, Inc.
    13. Marc A. Ragin & Benjamin L. Collier & Johannes G. Jaspersen, 2021. "The effect of information disclosure on demand for high‐load insurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 88(1), pages 161-193, March.
    14. Liran Einav & Amy Finkelstein & Iuliana Pascu & Mark R. Cullen, 2012. "How General Are Risk Preferences? Choices under Uncertainty in Different Domains," American Economic Review, American Economic Association, vol. 102(6), pages 2606-2638, October.
    15. Georges Dionne & Casey G. Rothschild, 2011. "Risk Classification in Insurance Contracting," Cahiers de recherche 1137, CIRPEE.
    16. Peter, Richard & Richter, Andreas & Thistle, Paul, 2017. "Endogenous information, adverse selection, and prevention: Implications for genetic testing policy," Journal of Health Economics, Elsevier, vol. 55(C), pages 95-107.
    17. Sebastian Soika, 2018. "Moral Hazard and Advantageous Selection in Private Disability Insurance," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 43(1), pages 97-125, January.
    18. Biener, Christian & Eling, Martin & Lehmann, Martin, 2020. "Balancing the desire for privacy against the desire to hedge risk," Journal of Economic Behavior & Organization, Elsevier, vol. 180(C), pages 608-620.
    19. Li Donni, P., 2010. "Risk Preference Heterogeneity And Multiple Demand For Insurance," Health, Econometrics and Data Group (HEDG) Working Papers 10/17, HEDG, c/o Department of Economics, University of York.
    20. Fleitas, Sebastian & Gowrisankaran, Gautam & Lo Sasso, Anthony, 2022. "Incumbent regulation and adverse selection: You can keep your health plan, but at what cost?," Journal of Public Economics, Elsevier, vol. 205(C).

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wly:empleg:v:17:y:2020:i:1:p:38-70. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://doi.org/10.1111/(ISSN)1740-1461 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.