Solvency Regulation and the Property-Liability "Insurance Cycle"

By Winter, Ralph A. | Economic Inquiry, July 1991 | Go to article overview

Solvency Regulation and the Property-Liability "Insurance Cycle"


Winter, Ralph A., Economic Inquiry


I. INTRODUCTION

The supply of property-liability insurance in the U.S. appears to be extraordinarily cyclical. Liability insurance lines in particular fluctuate between "soft markets" of stable premiums and low returns to insurers, and tight markets or insurance "crises" of rising premiums, cut-backs on availability and tight limits on coverage. The soft markets of the early 1970s and early 1980s were followed in 1975 and late 1984 by sudden premium increases, of hundreds of percent for some policies. (1) In mid-1987--early July according to some reports--the market began to turn around again. Premiums fell by as much as 40 percent and coverage limits increased up to 500 percent compared to the previous year. (2) In a previous paper (Winter [1988]), I addressed the puzzle of why some lines of insurance are apparently so vulnerable to fluctuations, when conventional economic theory predicts that premiums will change only one-for-one with the present value of expected claims.

This paper examines a specific allegation raised during the most recent insurance crisis: that existing regulation of property-liability insurance exacerbates market fluctuations. The principal enforcement role of state insurance commissions is to monitor the financial condition of insurers. Commissioners ensure that financial solvency standards are met so that policyholders are protected from the consequences of bankruptcy; more precisely, the regulations protect state guarantee funds, which assume the liabilities of bankrupt insurers. The regulators examine a number of financial ratios, but the dominant measure of financial leverage is the ratio of the current volume of business to net worth or surplus. Insurers are restricted by state commissioners from writing more insurance than considered justified by their current net worth in order that realized policy claims can be met, even if they turn out to be substantially higher than revenues would cover.

In determining the ratio of quantity of insurance to net worth, regulators face an aggregation problem. A sensible measure of the total quantity of insurance sold by a firm does not exist. The total number of policies sold, for example, is meaningless. Insurance commissioners therefore use premium revenues as a measure of the volume of business. Historically, insurers were allowed a value of two for the ratio of premiums to net worth before attracting the scrutiny of insurance commissioners. According to a standard text on insurance, published in 1982:

For more than 40 years, insurance

commissioners have used the 2-1 rule

as an indicator of the maximum safe

premium volume that property and

liability insurers might write. The

rule is that the premium volume

should not exceed two times policyholder

surplus (that is, net worth).

(Huebner et al. [1982])

The 2:1 rule was referred to as the Kenney rule, after the commissioner who first proposed it. The standard for a "safe" premium-to-net worth ratio has changed over time. Insurers in most states are now considered to meet solvency requirements when the ratio of premiums to net worth does not exceed three or four.

As a measure of financial leverage in solvency regulation, the premiums to net worth ratio has perverse effects. Suppose that demand is inelastic and that a supply shock to the market leads to an increase in premiums and hence revenue. Because the ratio of premiums to net worth has increased, regulatory pressures on insurers to maintain safe solvency standards will lead to even tighter supply. This regulatory pressure will lead to a further increase in premiums and revenue. Instead of signalling a more conservative leverage position, the ratio of premiums to net worth increases, leading to a more negative assessment by the regulator of the insurers' financial viability and hence to further pressure to raise premiums. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Solvency Regulation and the Property-Liability "Insurance Cycle"
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Author Advanced search

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.