Pricing power in insurance markets: evidence from South Africa

Abstract

PurposeIn less competitive markets, firms with market power are likely to exercise pricing power by setting output prices above their marginal cost, inducing welfare losses from resource misallocation, managerial inefficiency and market instability. In order to address such market imperfections, it is important for regulatory authorities to identify the sources of pricing power and devise policies to address their adverse effects. In this context, the purpose of this paper is to undertake an empirical analysis to identify the determinants of pricing power in the South African non-life insurance market.Design/methodology/approachThe authors estimate the Lerner competitive index as the proxy for pricing power using annual data on 79 firms from 2007 to 2012. In the second stage, the paper employs panel regression techniques in the ordinary least squares, random effects and generalised method of moment’s estimations to examine the effect of insurer level characteristics on pricing power.FindingsThe authors find the market to be characterised by firms with high pricing power. Domestic-owned insurers are found to exercise high pricing power compared with foreign-owned insurers. The authors also identify size, cost efficiency, product line diversification, market concentration, leverage and reinsurance contracts as the significant predictors of pricing power in the market. Finally, through a quantile regression analysis, the authors find the effect of cost efficiency, business line diversification and reinsurance to be heterogeneous across different quantiles of pricing power.Practical implicationsThe findings provide regulatory authorities with useful indicators in addressing anti-competitive behaviour in high pricing power to enhance the stability of the insurance market and improve consumer welfare and economic development.Originality/valueTo the best of the authors’ knowledge, this is first paper to examine the determinants of pricing power and competitive behaviour in an insurance market.