The Cost of Legal Restrictions on Experience Rating

46 Pages Posted: 16 Nov 2012 Last revised: 26 Jul 2018

See all articles by Levon Barseghyan

Levon Barseghyan

Cornell University

Francesca Molinari

Cornell University - Department of Economics

Darcy Steeg Morris

Government of the United States of America - Bureau of the Census

Joshua C. Teitelbaum

Georgetown University Law Center

Date Written: July 18, 2018

Abstract

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 under two models of risky choice. We find that the demand response is large but depends on the structure of risk preferences.

Keywords: claim rates, experience rating, insurance law, risk type, unobserved heterogeneity

JEL Classification: C58, D12, D82, G22, K23

Suggested Citation

Barseghyan, Levon and Molinari, Francesca and Steeg Morris, Darcy and Teitelbaum, Joshua C., The Cost of Legal Restrictions on Experience Rating (July 18, 2018). Georgetown Law and Economics Research Paper No. 12-040. Available at SSRN: https://ssrn.com/abstract=2176295 or http://dx.doi.org/10.2139/ssrn.2176295

Levon Barseghyan

Cornell University ( email )

Ithaca, NY 14853
United States

Francesca Molinari

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States
607-255-6367 (Phone)
607-255-2818 (Fax)

HOME PAGE: http://www.arts.cornell.edu/econ/fmolinari/

Darcy Steeg Morris

Government of the United States of America - Bureau of the Census

4600 Silver Hill Road
Washington, DC 20233
United States

Joshua C. Teitelbaum (Contact Author)

Georgetown University Law Center ( email )

600 New Jersey Avenue NW
Washington, DC 20001
United States
202-661-6589 (Phone)

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