The Cost of Legal Restrictions on Experience Rating
50 Pages Posted: 16 Nov 2012 Last revised: 2 Aug 2019
Date Written: July 24, 2019
We investigate the cost of legal restrictions on experience rating in auto and home insurance. The cost is an opportunity cost as experience rating can mitigate the problems associated with unobserved heterogeneity in claim risk, including mispriced coverage and resulting demand distortions. We assess this cost through a counterfactual analysis in which we explore how risk predictions, premiums, and demand in home insurance and two lines of auto insurance would respond to unrestricted multiline experience rating. Using claims data from a large sample of households, we first estimate the variance-covariance matrix of unobserved heterogeneity in claim risk. We then show that conditioning on claims experience leads to material refinements of predicted claim rates. Lastly, we assess how the households’ demand for coverage would respond to multiline experience rating. We find that the demand response would be large.
Keywords: claim rates, experience rating, insurance law, risk type, unobserved heterogeneity
JEL Classification: C58, D12, D82, G22, K23
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