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Detail Outline for Exam 7 – 2007 Part C - page 14 / 28

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Nyce, Foundations of Risk Management and Insurance – SK

Doesn’t replace normal channels of insurance; only for consumers unable to get insurance in private market.

Residual Auto Plans

Make compulsory auto cvg available to high-risk drivers who have difficulty purchasing cvg at a reasonable rate in private market.

Varies by state.  Usually an insurance pool of privates to meet an unmet need for compulsory cvg.

Doesn’t replace normal channels of insurance; only for consumers unable to get insurance in private market.

Bartlett, "Attempts to Socialize Insurance Costs in Voluntary Insurance Markets: The Historical Record," Journal of Insurance Regulation – SK

Introduction – goal is to lower premiums for high-risk insureds.

Justifications for socialization:

An equal sharing of insurance costs among individuals is fairer than one based on relative risk or the benefits they can expect to receive.

Risk-based prices hurt low/middle income individuals.

There’s a limit to what someone should pay for insurance. (affordable)

Risk-based prices will discourage some from not getting insurance.

Socialization is most feasible when participants are legally compelled to participate and insurance is administered by a single entity w/ no competition.

Also feasible if private insurer is insulated from competition or its profits subject to expropriation by the govt.

Also feasible if participants believe the overall benefits exceed the costs of socialization.

Most difficult when individuals can choose among competing insurers or opt out.  Low-risk individuals will avoid subsidizing the high-risks.  And insurers will attempt to circumvent regulatory constraints or withdraw.

Socialized Pricing and Market Forces

Social Insurance – for example, Social Security, which has uniform rates (%-age of wages).  Low-risk workers can’t opt out.  Such a program works only if structured properly and has strong political support.

Private Insurance Markets Under Regulation – in general, individuals want the lowest price for service.  Under competition, an insurer will charge price reflecting insured’s risk and benefits.  Insurers and low-risk individuals will try to circumvent govt constraints to avoid cross subsidies for high-risk insureds.

Cross subsidies for high-risks come from either low risks or the insurers.

These subsidies come from: entry/exit barriers; market power; special cost advantages; value of firm reputation; switching costs for consumers; constraints on consumer info.

Barriers to exit a market:

Prior notice requirements for policy terminations.

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