I haven't tried to make any questions with the graphs but that does see=
m
testable... maybe someone else would like to tackle that? Or do you th=
ink
it's too much a re-hash of parts 5 and 9 and so they probably won't ask=
it?
Alice
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****
******************************
True/False:
1) Classification schemes can affect the total cost of risk.
2) The direct efficiency consequences of restrictions on classification=
are
ambiguous.
3) There is no evidence to support the idea that that "classification
restrictions in auto insurance do not affect driving habits".
4) According to the evidence, the direct efficiency losses from
classification restrictions in auto insurance would likely be large.
5) Direct efficiency losses from restrictions on classification would b=
e
very difficult to measure.
6) For auto insurance, market prices equal to marginal expected costs o=
f
coverage would have undesirable implications for efficiency.
7) If a pooled rate is mandated, it is possible that low-risk consumers=
could be made worse off without making high-risk consumers any better o=
ff.
8) The cost of obtaining information encourages homogeneity in
market-determined rate classes.
9) The net benefits of market classification will be much lower with
imperfect and costly information.
10) Costly classification would benefit low risks and disadvantage high=
risks.
11) Whether the insurance market engages in "too much classification" i=
s
ambiguous.
12) To be effective and avoid market dislocations, significant restrict=
ions
on classification will require additional regulation.
13) Comprehensive restrictions on classification would likely decrease =
the
size of the involuntary market.
14) Proponents on restriction of classification commonly advocate that =
less
weight be given to an individual's driving record.
15) Classification restrictions are usually accompanied by open competi=
tion
rate regulation.
16) A group's ability to obtain benefits from regulation depends primar=
ily
on its ability to exert lobbying pressure.
17) Classification restrictions could significantly increase the cost o=
f
risk even if their effects on decisions to drive, to buy coverage, and =
to
exercise care were modest.
Essay:
1) Name 2 likely indirect effects of restriction on classification.
2) Name 4 types of information which have been restricted in some state=
s
for use as classification variables.
3) Define Pareto efficiency, and explain why it has limited applicabili=
ty.
4) Define "efficiency" in the sense used by Harrington.
5) Name 2 important issues in the controversy over risk classification.=
6) Explain two responses high-risk drivers would likely have, if an equ=
al
pooled rate were mandated for all drivers.
7) Explain "indifference curve". Draw a typical indifference curve as =
per
Harrington.
8) Explain why a single pooled-rate policy will not exist in equilibriu=
m.
9) Give one factor which serves as an incentive for insurers to achieve=
accurate classification, and one factor which serves as a disincentive.=
10) Name two criticisms which have been leveled at market classificatio=
n
practices. For each, give a counterargument.
11) Explain the difficulties with serious restrictions on classificatio=
n,
if the residual market is handled by (a) assigned risk plan (b) reinsur=
ance
facility (c) JUA.
12) Give an example of a state which restricted classification and expl=
ain
what additional regulation ensued.
13) List 4 effects of placing too much weight on individual insureds'
driving history.
14) Give 4 effects of increased government control on rates.
15) What are the 3 main functions of private sector provision of covera=
ge
at competitive prices?
16) Give 4 conditions which make classification restrictions more likel=
y to
be implemented.
ANSWERS
***********************************************************************=
****
****************************************************
True/False:
1) Classification schemes can affect the total cost of risk.
T, p.59
2) The direct efficiency consequences of restrictions on classification=
are
ambiguous.
T, p.61
3) There is no evidence to support the idea that that "classification
restrictions in auto insurance do not affect driving habits".
F, p.61
4) According to the evidence, the direct efficiency losses from
classification restrictions in auto insurance would likely be large.
F, p.61; also see p. 63-64
5) Direct efficiency losses from restrictions on classification would b=
e
very difficult to measure.
T, p.61
6) For auto insurance, market prices equal to marginal expected costs o=
f
coverage would have undesirable implications for efficiency.
F, p.63
7) If a pooled rate is mandated, it is possible that low-risk consumers=
could be made worse off without making high-risk consumers any better o=
ff.
T, p.66 This is the self-separating equilibrium in which high risks bu=
y
full coverage and low risks only partial coverage, each at the actuaria=
lly
fair rate
8) The cost of obtaining information encourages homogeneity in
market-determined rate classes.
F, heterogeneity. p. 69
9) The net benefits of market classification will be much lower with
imperfect and costly information.
T, p.69
10) Costly classification would benefit low risks and disadvantage high=
risks.
T, p.70
11) Whether the insurance market engages in "too much classification" i=
s
ambiguous.
T, p.72
12) To be effective and avoid market dislocations, significant restrict=
ions
on classification will require additional regulation.
T, p.72
13) Comprehensive restrictions on classification would likely decrease =
the
size of the involuntary market.
F, p.73
14) Proponents on restriction of classification commonly advocate that =
less
weight be given to an individual's driving record.
F, p.75
15) Classification restrictions are usually accompanied by open competi=
tion
rate regulation.
F, p.75
16) A group's ability to obtain benefits from regulation depends primar=
ily
on its ability to exert lobbying pressure.
T, p.77
17) Classification restrictions could significantly increase the cost o=
f
risk even if their effects on decisions to drive, to buy coverage, and =
to
exercise care were modest.
T, p.80
Essay:
1) Name 2 likely indirect effects of restriction on classification.
a) Increase cost of risk by distorting incentives for claim settlement =
and
for legislative actions to control costs
b) Seriously weaken the case for private sector provision of coverage =
p.
59
2) Name 4 types of information which have been restricted in some state=
s
for use as classification variables.
Age, sex, marital status, territory; p.59
3) Define Pareto efficiency, and explain why it has limited applicabili=
ty.
This exists when no person can be made better off without making someon=
e
else worse off. p.61
Limited applicability because most regulatory policy issues involve cho=
ices
that will make at least some people worse off, p.62
4) Define "efficiency" in the sense used by Harrington.
More efficient means that the cost of risk is lower. Cost of risk is
defined as the sum of direct costs of accidents and dispute resolution,=
the
cost of risk control, the cost of risk avoidance, and the cost of risk
bearing and risk transfer. p.62
5) Name 2 important issues in the controversy over risk classification.=
a) Variables used are imperfect indicators of risk (imperfect informati=
on).
b) Obtaining better classification information may be costly. p.62
6) Explain two responses high-risk drivers would likely have, if an equ=
al
pooled rate were mandated for all drivers.
a) They would be more likely to buy coverage (could also say they would=
be
more likely to drive)
b) They would be likely to buy larger amounts of coverage p.64-67
7) Explain "indifference curve". Draw a typical indifference curve as =
per
Harrington.
Consumers are equally well off -- i.e. have equal expected utility -- f=
or
all points along such a curve. p.67
Harrington's curves compare deductible along the x axis with insurance
premium along the y axis, so the curves are decreasing and generally
concave down.
8) Explain why a single pooled-rate policy will not exist in equilibriu=
m.
It is vulnerable to the introduction of a policy with a higher deductib=
le
which attracts primarily low-risk insureds and produces profits for the=
insurer. With too many high risk insured left buying the pooled policy=
, it
becomes unprofitable.
9) Give one factor which serves as an incentive for insurers to achieve=
accurate classification, and one factor which serves as a disincentive.=
Incentive: antiselection (competition and profit maximization).
Disincentive: cost of information. p.69
10) Name two criticisms which have been leveled at market classificatio=
n
practices. For each, give a counterargument.
a) Insurers use arbitrary or superfluous information.
This doesn't make sense because the use of nonpredictive information wi=
ll
not be rewarded over time and could easily lead to negative profits.
b) Insurers fail to use low-cost information which does help to predict=
claim costs.
This is inconsistent with profit seeking in a competitive environment.
Insurers have an incentive to use such data even if increases in predic=
tive
accuracy are modest. p.69
11) Explain the difficulties with serious restrictions on classificatio=
n,
if the residual market is handled by (a) assigned risk plan (b) reinsur=
ance
facility (c) JUA.
a) Concentration of residual market in urban areas is inconsistent with=
disallowing territory as a rating variable. Insurers have less incenti=
ve
to provide quality service to assigned risks. Insurers may be assigned=
risks in areas where they have no marketing outlets or claim facilities=
..
If there is a take all comers provision, insurers might reduce their
marketing outlets in urban areas. The market might segment into urban =
and
non-urban carriers.
b) Many of the problems in (a) would be mitigated, but due to risk shar=
ing
each servicing carrier has reduced incentive to control fraud and other=
costs.
c) Same comments as for (b) p.73-74
Comment -- this is a complicated issue and seems like it could very wel=
l be
asked. I'm not sure I've done a very good job with my sample answer. =
I
would be glad to hear how you think the answer could be improved!
12) Give an example of a state which restricted classification and expl=
ain
what additional regulation ensued.
Michigan in 1981 restricted territory and sex as rating variables for a=
uto.
Additional regulation: created JUA; co's must take all comers who meet
their UW criteria, co's cannot pool experience of involuntary and volun=
tary
market. In 1986 the state relaxed restrictions on territory because th=
e
effect had been large market dislocations. p.74
Also you could talk about CA prop 103 -- see p.79
13) List 4 effects of placing too much weight on individual insureds'
driving history.
Excessively high level of deterrence; drivers could be exposed to exces=
sive
risk; might discourage the reporting of accidents and violations; might=
increase the frequency of hit-and-runs. p.75
14) Give 4 effects of increased government control on rates.
rate increases may lag behind claim costs; might reduce insurer incenti=
ves
to provide quality coverage; might increase incentives to exit the mark=
et;
might reduce diversity of coverage and service. p.76
15) What are the 3 main functions of private sector provision of covera=
ge
at competitive prices?
incentive for consumers to minimize cost of risk; incentive for insurer=
s to
settle claims efficiently; encourage diversity in coverage and service.=
p.76
16) Give 4 conditions which make classification restrictions more likel=
y to
be implemented.
supported by organized interest groups; premium increases necessary to
finance other reductions can be delayed or spread broadly; parties whos=
e
rates increase are ignorant of this effect; adverse behavioral effects =
and
efficiency losses are small. p.78
=