The Moral Hazard of Insuring the Insurers

James G. Bohn and Brian J. Hall

No 5911, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: State guaranty funds are quasi-governmental agencies that provide insurance to policyholders against the risk of insurance company failure. But insurance provided by guaranty funds, like all insurance, creates moral hazard problems, especially for companies that are insolvent or near-insolvent. The key insight of this paper is that because of the time lag between premium payments and losses (which is especially lengthy in long-tail lines), writing policies is one way for insurance companies to borrow money (i.e., from policyholders). Moreover, the existence of guaranty fund insurance enables insurance companies, even very risky ones, to borrow from policyholders at rates that do not reflect the insurer's default risk. Thus, one way for insurance companies to game the guaranty fund system is to engage in excessive premium writing. Consistent with this idea, we find that insolvent P&C insurance companies tended to have very high premium growth before they failed. More than one-third of the failed insurance companies had premium growth of more than 50 percent in the two years before failure. Moreover, this excessive premium growth was more pronounced in long-tail lines than in short-tail lines. We also find evidence that greater regulatory resources are associated with less gaming of the system.

Date: 1997-01
Note: PE
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Published as Bohn, James G. and Brian J. Hall. "The Costs of Insurance Company Failures" . The Economics of Property-Casualty Insurance. Edited by David F. Bradford, Chicago: The University of Chicago Press, 1998, pp. 139-166.
Published as (REF) The Financing of Catastrophe Risk. Froot, Kenneth A., ed., Chicago: The University of Chicago Press, 1999, pp. 363-384.
Published as The Moral Hazard of Insuring the Insurers , James G. Bohn, Brian Hall. in The Financing of Catastrophe Risk , Froot. 1999

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