Regulation in the Insurance Industry: Determination of Premiums in Automobile Insurance

Abstract

The controlled rates in the insurance industry must, on the one hand, ensure profitability and solvency of the insurance companies, and on the other hand, avoid exorbitant charges. Measuring the ex-post profit of insurance companies for rates determination is impracticable, since approximations are used in the evaluation of the outstanding claims. In addition to that, the allocation of income from investment to the business account of each field that the company deals with, is arbitrary. The authors suggest an econometric model for rates determination. They estimate the average claim as well as the probability for a claim. This method can be used in order to determine the controlled rates. Moreover, the suggested method proved to be useful in determining the rates for specific groups of policyowners as well as for selecting the desired policyowners. Companies should carry out from time to time such an empirical research in order to improve their sales policy. Automobile insurance rates must be approved by the government. Such controlled rates should, on the one hand, ensure the profitability and solvency of insurance companies, and on the other, avoid exorbitant charges. The determined rates should, of course, be revised from time to time. Theoretically, this can be done by examining the profit-and-loss accounts of the insurers: losses mean that rates should be increased, while excessive profits mean that they should be reduced. This method, however, is rendered impracticable by the accounting techniques employed in the profitand-loss accounts of insurance companies, which restrict their usefulness, Yehuda Kahane, Ph.D., served as Visiting Professor in the University of Florida 1973-74, while on leave from his position of Lecturer in The Hebrew University of Jerusalem. Haim Levy, Ph.D., is Director of the School of Business Administration and Associate Professor in The Hebrew University of Jerusalem. He is co-author of Investment and Portfolio Analysis. This paper was submitted in December, 1973. This paper summarizes the theoretical problems encountered and some of the empirical results found by the authors in a comprehensive study on rate determination for automobile insurance in Israel. This study has been financed by the Israel Union of Insurance Companies and by the Insurance and Savings Authority, The Ministry of Finance, Government of Israel. The authors wish to thank Mr. Ben Horim for his help in this study and two anonymous referees for their helpful comments.