With over $235 billion of direct premiums written per year, the economic performance of the U.S. property-liability insurance industry is of major interest to financial service consumers and government policy-makers. This article analyzes the economic performance of the U.S. property-liability insurance industry, focusing on differences in performance across lines of insurance. We adopt a broad pragmatic definition of economic performance that places a major emphasis on the pricing of insurance to consumers and the cost of producing insurance.
Intensity of competition can influence the performance of an industry. The property-liability insurance industry has a long history of efforts to coordinate the setting of premium rates. The industry also has had a relatively broad exemption from federal antitrust laws since the passage of the McCarran-Ferguson Act of 1945.(1) For example, until at least 1990 (see Joskow and McLaughlin, 1991), "rating bureaus" and similar industry associations issued rates that either were required for bureau members or were disseminated as "advisory." Although exemption from federal antitrust laws is based on the existence of state regulation, the objectives and intensity of state regulation vary across insurance lines and over time. We examine the role of competition in different lines of insurance by looking at whether line performance is affected by the concentration of market share in each line or by the importance of alternative strategic distribution channels for insurance.
Little is known about the intensity of competition and its impact on insurance prices nationally across different property-liability insurance lines. Most empirical studies of the pricing of property-liability insurance (e.g., Ippolito, 1979; Witt and Urrutia, 1983; Cummins and Harrington, 1987; Harrington, 1987; and Grabowski, Viscusi, and Evans, 1989) focus on one or a few lines - typically forms of automobile insurance - and on the effects of different types of state regulation on prices. Joskow and McLaughlin (1991) argue that many firms operate nationally or across many states in each line of insurance. Barriers to mobility across state boundaries are modest, assets and expertise are easily transferred, and meeting additional states' entry regulations is generally easy, so that the potential elasticity of supply across states appears to be high for any given line of insurance. On the other hand, barriers to mobility exist between different lines of insurance, perhaps arising from limits to expertise, unwillingness to assume the competitive risks involved in confronting firms already established in a given line, or other sources. We therefore posit that different lines of insurance form relatively distinct markets whose structure, behavior, and performance vary, and these performance differences can persist over time.(2)
PRICE, PERFORMANCE, AND THEIR DETERMINANTS
To explore issues relating to the economic performance of the property-liability insurance industry, this article presents a statistical analysis of the determinants of the economic loss ratio - a variable used in previous research to represent pricing performance. Let [P.sub.t] be the premiums on policies written in year t, [LSUM.sub.t] = PV[[L.sub.t], ..., [L.sub.T]] be the sum of the present value of expected losses on these policies over time [t,...,T; T [greater than] t], and [C.sub.t] be the cost and expenses associated with providing insurance. Then the economic loss ratio is [LSUM.sub.t]/([P.sub.t] - [C.sub.t]). It is essentially the reciprocal of a type of price-cost margin, in which premiums represent the price of insurance, and costs include both the present value of claims and other costs of providing insurance. Although precise cash flow data for policies are not available, we can use accounting data to construct estimates of the economic loss ratio. The procedure used to construct the proxy follows the approach used by Winter (1994) and is described in the Appendix. …