Evidence on Adverse Selection: Equilibrium Signaling and Cross-Subsidization in the Insurance Market.

The configuration of equilibrium in the market for automobile collision insurance is examined empirically by representing the premium-deductible menu and the demand function as a standard hedonic system. Using contractual data from a representative insurer, the authors estimate a reduced-form hedonic premium equation and the inverse of the marginal bid equation for insurance coverage. The data reveal an equilibrium with adverse selection and market signaling but lead the authors to reject the hypothesis that high risks receive contracts subsidized by low risks. Copyright 1994 by University of Chicago Press.

Optimal Incentive Contracting with Ex Ante and Ex Post Moral Hazards: Theory and Evidence

Predictions concerning structure and performance for managerial incentive contracts designed to prevent accidents are developed and tested. The model predicts a step-function penalty with more costly, more reliable audits used for higher loss reports to control ex post exaggeration of the loss. In addition, the penalty induces nonreporting that is imperfectly controlled through random audits. An empirical contract implemented to control workers\u27 compensation medical losses provides evidence consistent with these predictions. The contract reduces both accident frequency and total losses, but increases reported loss severity as managers evade approximately 40 percent of the accident penalty by underreporting small losses

The Effect of Legal Rules on the Value of Economic and Non-Economic Damages and the Decision to File

This study focuses on the economic consequences of tort reform. In particular, we address two issues. First, we test the relationship between tort reforms and claim severity for an automobile liability incident while controlling for a variety of cost drivers including the presence of no-fault rules, and the impact of a plaintiff\u27s attorney. In addition to examining the effect of tort reforms on total claim severity, we also test their effect on economic and non-economic damages separately. Second, we test the proposition that tort reforms, by reducing the damages available at trial, have reduced the likelihood that an injured party will seek legal remedy. Both aspects of this study are examined with individual data from a large sample of insurance claims from 61 insurers. Our results suggest that many of the reforms have had a statistically significantly effect on total damages, non-economic damages and economic damages. Caps on non-economic damages, collateral source rule reforms, and minor reforms impacting prejudgment interest, frivolous suits, and provisions for periodic payments are negatively related to the value of non-economic claims, while joint and several reform is positively related to the value of non-economic claims. We find collateral source rule reforms and minor reforms are negatively related to the value of economic claims. We find that caps on non-economic damages and minor reforms are associated with a decreased probability to file. We do not find any evidence that joint and several or collateral source rule reform is associated with the decision to file

Insurance Claim Operations: The Role of Economic Incentives

We develop a theory of insurance claim settlement whose structure embodies an insurer’s capacity decision and negotiation between the insurer and claimant in an asymmetrically informed environment. We offer a solution to an insurer’s choice of upfront claim settlement amount under a plausible set of assumptions. Implications from theory are tested with a large sample of liability insurance claims collected over two years in the state of Texas and we find that insurer’s deployment of more capacity to handle a claim and longer settlement times occur for claims with more uncertainty. The empirical results also reveal factors relevant to insurer’s operational choices. Descriptive features of a claim, the age of the claimant and attorney representation on the plaintiff’s side are important determinants of the final settlement amount

The Effect of Bad-Faith Laws on First-Party Insurance Claims Decisions

This Article represents the first empirical study of the effects of bad-faith laws on claims decisionmaking by insurance companies. One of the most notable and debated developments in the law of tort and insurance since the 1970s has been the recognition in many states of an extracontractual cause of action against insurers for the bad-faith denial of a claim filed by an insured for benefits allegedly due under the policy. We examine whether the existence of this remedy affects the amount, timing, or allocation of payments to insureds made in the “shadow of the law” of bad faith. We drew on the 1992 closed claims database developed by the Insurance Research Council compiling thousands of closed claims under automotive insurance policies by over 60 insurance companies. These claims include many categories of payments; we concentrated on claims for uninsured motorist coverage (UM) or underinsured motorist coverage (UIM) because these are categories of “first-party” insurance to which the extracontractual bad faith remedy applies in states that allow such a remedy. Although a majority of states recognizes a remedy for bad faith, 15 states within the IRC database did not recognize bad faith claims. Thus, by controlling for other variables that could affect payment - including significance of injury, tort reform measures, attorney involvement, and others - we could determine whether the existence of a bad faith remedy affects the timing, amount, or allocation of insurance payments for UM or UIM claims. The study shows that the presence of a bad faith remedy is tied to higher claims payments for claims. In addition, the higher overall settlements apply both to the economic and to the noneconomic aspects of the damages underlying the claims. Further, and somewhat surprisingly, we found that bad faith laws are associated with a greater increase in settlement amounts when plaintiffs are not represented by an attorney