Theoretical Foundations of Community Rating by a Private Monopolist Insurer: Framework, Regulation, and Numerical Analysis

TL;DR

This paper develops a theoretical framework for community rating in insurance using monopoly models, establishing conditions for optimal premiums and analyzing the effects of regulation through numerical simulations.

Contribution

It introduces a novel theoretical model for community rating within a monopoly insurance setting and provides numerical analysis of regulatory impacts.

Findings

Optimal premium is unique and follows the inverse elasticity rule.

Regulation can increase indemnity by 10% with minimal effects on other variables.

Profitability conditions are characterized under mild regularity assumptions.

Abstract

Community rating is a policy that mandates uniform premium regardless of the risk factors. In this paper, our focus narrows to the single contract interpretation wherein we establish a theoretical framework for community rating using Stiglitz's (1977) monopoly model in which there is a continuum of agents. We exhibit profitability conditions and show that, under mild regularity conditions, the optimal premium is unique and satisfies the inverse elasticity rule. Our numerical analysis, using realistic parameter values, reveals that under regulation, a 10% increase in indemnity is possible with minimal impact on other variables.