Surviving Price Deregulation

Theory and evidence from the past two decades demonstrate that price deregulation increases efficiency and lowers costs and prices. The impact of deregulation on profit, however, is ambiguous and depends in part on the industry's market structure. Theory predicts that, in competitive industries, price deregulation tends to reduce prices by about as much as costs, producing little change in profit. In industries with monopolistic characteristics, however, price deregulation may permit higher profits for the surviving firms. This paper argues that price deregulation itself can have a profound impact on an industry's market structure. Understanding how this change in market structure may occur is crucial in predicting the impact of price deregulation on an industry's profitability. This paper focuses on how price deregulation is likely to impact the U.S. auto insurance industry. At present, the industry is competitive. Unlike the transportation industries, existing regulation has not seriously impeded entry into or exit from the market. In this competitive market environment, price deregulation may exert only a minimal impact on profits. On the other hand, increased pricing freedom is likely to stimulate development of new technologies for varying rates and segmenting markets, similar to those developed by the deregulated airline industry. Specifically, price deregulation will lead to more sophisticated class plans, more frequent rate changes, and more consumer shopping. To exploit these changes, insurers must integrate computer systems, increase employee skills in gathering and analyzing customer data, and offer high quality, individualized service. Price deregulation, thereby, may create new profit opportunities for the largest existing insurers, who possess the data and expertise for sophisticated analysis. Actuaries need to be prepared for these changes.