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A Behavioral Model of Insurance Pricing

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  • James A. Ligon
  • Paul D. Thistle

Abstract

We develop a model of price competition between insurers where insurers maximize expected profit subject to a solvency constraint. Insurers base prices in part on expected losses, the estimates of which are updated in a Bayesian fashion. We assume that insurers are overconfident—they overestimate the precision of their private signal about expected losses. This leads insurers to overreact to their private signal on expected losses. The consequence is that prices may cycle and that the distribution of price changes may be positively skewed because of the role played by the solvency constraint.

Suggested Citation

  • James A. Ligon & Paul D. Thistle, 2007. "A Behavioral Model of Insurance Pricing," Journal of Insurance Issues, Western Risk and Insurance Association, vol. 30(1), pages 46-61.
    • Handle: RePEc:wri:journl:v:30:y:2007:i:1:p:46-61
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    Cited by:

    1. Iqbal Owadally & Feng Zhou & Douglas Wright, 2018. "The Insurance Industry as a Complex Social System: Competition, Cycles and Crises," Journal of Artificial Societies and Social Simulation, Journal of Artificial Societies and Social Simulation, vol. 21(4), pages 1-2.
    2. Apostolos Kiohos, 2020. "Risk Affection and Transmission of News of Conditional Volatility from the Non-Life to Life Insurance Sector," Bulletin of Applied Economics, Risk Market Journals, vol. 7(2), pages 77-86.

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