Is the Risk-Based Mechanism Always Better? The Risk-Shifting Behavior of Insurers under Different Guarantee Schemes

Ming (Ivy) Dong, Helmut Gruendl and Sebastian Schluetter
Authors registered in the RePEc Author Service: Helmut Gründl

Journal of Insurance Issues, 2015, vol. 38, issue 1, 72-95

Abstract: Insurance guarantee schemes (IGSs) aim to protect policyholders from thecosts of insurer insolvencies. However, IGSs can also reduce the incentives of insurersto conduct appropriate risk management. We investigate the risk-taking behavior of astock insurer under insurance guarantee schemes with two different financing alter-natives: a flat-rate premium assessment versus a risk-based premium assessment.Previous studies indicate that the flat-rate premium assessment can induce insurers totake more risks, a problem that can be resolved under the risk-based premiumassessment. Our results show that the risk-taking incentive of the insurer can also occurunder the risk-based IGS. The risk-based mechanism is superior to the flat-rate oneonly if an appropriate premium loading is included. Furthermore, we identify whichIGS leads to higher policyholders’ welfare, measured by their expected utility. We findthat the risk-based IGS can be more advantageous in improving the policyholders’welfare due to the limited risk of the insurer, compared to the flat-rate IGS.

Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:wri:journl:v:38:y:2015:i:1:p:72-95

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