Dynamic Investment-Driven Insurance Pricing and Optimal Regulation

TL;DR

This paper examines how insurers' investment and underwriting strategies interact in a dynamic market, revealing conditions for market success, failure, and the role of regulation in optimizing social welfare.

Contribution

It introduces a dynamic model of insurance markets incorporating investment strategies and regulatory effects, highlighting why insurers may accept underwriting losses for investment gains.

Findings

Insurers may accept underwriting losses by setting negative safety loadings.

Negative correlation between insurance gains and financial returns influences insurer behavior.

Regulatory costs can improve social welfare under certain market conditions.

Abstract

This paper analyzes the equilibrium of insurance market in a dynamic setting, focusing on the interaction between insurers' underwriting and investment strategies. Three possible equilibrium outcomes are identified: a positive insurance market, a zero insurance market, and market failure. Our findings reveal why insurers may rationally accept underwriting losses by setting a negative safety loading while relying on investment profits, particularly when there is a negative correlation between insurance gains and financial returns. Additionally, we explore the impact of regulatory frictions, showing that while imposing a cost on investment can enhance social welfare under certain conditions, it may not always be necessary.