Bartlett, "Attempts to Socialize Insurance Costs in Voluntary Insurance Markets: The Historical Record," – SK
Severe restrictions on policy terminations, U/W-ing selection, and exit.
If a company leaves a line, they may lose economies of scope in marketing multiple insurance products.
Insurers would lose sunk costs of establishing operations in the state they withdraw from.
Regulators may require exit from all lines.
Mechanisms for Imposing Cross Subsidies
Constraints – govt may constrain differences in rates among risk classes, and also possibly the overall rate level as well.
U/W-ing risk factors – govt may ban or limit these. Often insurers classify themselves through U/W standards. “Preferred” write business to only the best. “Standard” and “non-standard” are more lenient and charge higher rates. (One way to get around constraints except when govt restricts U/W-ing factors.) This leads to market skewing.
Some low-risk insureds may stay w/ an insurer – if it’s costly to switch to another company; if consumers value the insurer reputation. Thus an insurer may cross-subsidize w/o losing business. Most likely when the difference to low-risk is small.
Can insurer then make an excess profit? Not likely if regulatory monitoring discourages them to do so. Also, charging excessive prices for low-risks will eventually cause insureds to go elsewhere. Insurer may be forced to absorb the subsidy costs.
Over the long-run, the govt’s ability to perpetuate cross subsidies in a competitive market should diminish over time.
Residual Market Mechanisms (RMMs)
These tend to be populated by high-risk individuals.
Sometimes, RMMs may provide lower rates. (Interesting.)
RMMs are typically constrained and run operating deficits funded through pro-rata assessments on voluntary insurance premiums. (Passing the subsidies on to the low-risks.) This could discourage insurers from writing voluntary business and/or low-risks buying insurance.
Low RMM prices can encourage moral hazard & cost inflation.
Some jurisdictions provide economic incentives: “take out credits” to insurers that accept risks out of the residual market (thus depopulating the RMMs).
Voluntary Cross Subsidization
Imperfections in Risk Classification
Assessment Life Insurance
Early History – Death claim payments are funded by assessments after the death instead of through premiums before the death. Popular late 19th Century and early 20th.
Originally begun by cooperative associations.
Membership dues provide funds for relief to widows & orphans, w/ no guarantees about the amt of pmts to receive in future.