Insurance, Risk Management, and Public Policy: Essays in Memory of Robert I. Mehr

187 Pages·1994·5.08 MB·English

by  Michael L. Smith

INSURANCE, RISK MANAGEMENT,
AND PUBLIC POLICY
Essays in Memory of
Robert I. Mehr
Huebner International Series on
Risk, Insurance, and Economic
Security
J. David Cummins, Editor
The Wharton School
University of Pennsylvania
Philadelphia, Pennsylvania, USA
Series Advisors:
Dr. Phelim P. Boyle
University of Waterloo, Canada
Dr. Jean Lemaire
University of Pennsylvania, USA
Professor Akihiko Tsuboi
Kagawa University, Japan
Dr. Richard Zeckhauser
Harvard University, USA
Other books in the series:
Cummins, J. David and Derrig, Richard A.: Classical
Insurance Solvency Theory
Borba, Philip S. and Appel, David: Benefits, Cosrs, and
Cycles in Workers' Compensation
Cummins, J. David and Derrig, Richard A.: Financial Models
of Insurance Solvency
Williams, C. Arthur: An Imemariol/al Comparison of
Workers' Compensation
Cummins, J. David and Derrig, Richard A.: Managing the
Insolvency Risk of Insurance Compallies
Dionne, Georges: COllfributions to Insurance Economics
Dionne, Georges and Harrington, Scott E.: Foundations of
Insurance Economics
Klugman, Stuart A.: Bayesian Statistics in AClUarial Science
Durbin, David and Borba, Philip: Workers' Compensation Insurance:
Claim Costs, Prices alld Regulatioll
Cummins, J. David: Financial Management of Life Illsurance
Companies
INSURANCE, RISK MANAGEl\iENT, AND
PUBLIC POLICY
Essays in Memory of Robert 1. Mehr
edited by
Sandra G. Gustavson
University of Georgia
Athens, GA
and
Scott E. Harrington
University of South Carolina
Columbia, SC
~.
"
Springer Science+Business Media, LLC
ISBN 978-94-010-4603-9 ISBN 978-94-011-1378-6 (eBook)
DOI 10.1007/978-94-011-1378-6
Library of Congress Cataloging-in-Publication Data
Insurance, risk management, and public policy : essays in memory of
Robert 1. Mehr / edited by Sandra G. Gustavson and Scott E.
Harrington.
p. cm. -- (Huebner international series on risk, insurance,
and economic security)
Includes index.
1. Risk (Insurance) 2. Risk management. I. Mehr, Robert Irwin,
1917- . II. Gustavson, Sandra G. III. Harrington, Scott E.
IV. Series.
HG8054.5.1574 1994
368--dc20 93-36035
CIP
Copyright <C> 1994 by Springer Science+Business Media New York
Originally published by Kluwer Academic Publishers in 1994
Softcover reprint ofthe hardcover Ist edition 1994
AH rights reserved. No part of this publication may be reproduced, stored in
a retrieval system or transmitted in any form or by any means, mechanical,
photo-copying, recording, or otherwise, without the prior written permission of
the publisher, Springer Science+Business Media, LLC.
Printed on acid-free pap er.
Contents
Preface vii
1 1
The Law of Large Numbers and the Strength of Insurance
Michael L. Smith and Stephen A. Kane
2 29
Corporate Insurance, Reinvestment, and Capital Structure
Neil A. Doherty and James R. Garven
3 49
Measuring the Interest Rate Risk of Property/Casualty
Insurer Liabilities
David F. Babbel and David R. Klock
4 75
Managing Domestic Versus Foreign Risks
Joan T. Schmit, Kendall Roth and Rick G. Winch
5 93
Potential Price and Product Quality Changes for
Insurance Delivered by Banks
S. Travis Pritchett
6 115
Taxing Low Income Households in Pursuit of the Public Interest:
The Case of Compulsory Automobile Insurance
Scott E. Harrington
vi Insurance, Risk Management, and Public Policy
7 139
The Effects of Shifting Medical Expense from PIP
Auto Coverage to First Party Health Insurance
Patricia M. Danzon
8 163
The Dark Side of Insurance
Stephen P. D'Arcy
Index 183
Preface
Five years ago the world lost one of its most prolific insurance
scholars, Dr. Robert I. Mehr. His death in 1988 signalled the passing of
not only a gifted writer and researcher, but also a pioneering teacher,
mentor, and friend. The essays compiled within this volume are
intended as an appropriate tribute to this occasionally outrageous
individual who touched the lives of so many within the insurance
community.
Bob Mehr was a teacher who expected and demanded nothing
less than perfect scholarship and flawless, efficient writing. Among
alumni of the University of lllinois insurance doctoral program, stories
still abound of late night and early morning sessions in which students
and professor painstakingly debated precise words and phrases for
dissertations, journal articles, and textbooks. Bob's respect for language
was both immense and contagious, if at times more than a little
compulsive. He joked that he could not read letters or novels without
pencil in hand for editing.
Bob's respect for his doctoral students was equally evident. The
confidence he displayed in his students' abilities was sometimes startling,
but "competence assumed" often begot "competence in fact." The
accomplishments and records amassed by the many who studied with
Bob Mehr are impressive and ongoing. On the dedication page in his
final textbook, Fundamentals of Insurance, Bob spoke of his affection for
those he called his "academic progeny" and wished them happiness as
they build their own academic families.
The legacy of Bob Mehr was established through incredibly
focused attention and a relentless work ethic. When blizzards in central
lllinois closed interstate highways and forced him into a community
center shelter for several days, Bob used the time to edit galley proofs for
a revision of one of his 14 books. As chronic health problems robbed
him of the ability to sleep for very long at a time, Bob simply worked
more. His accomplishments included not only his writings and his
viii Insurance, Risk Management, and Public Policy
students, but also nearly every leadership position and honor in
insurance academia. A small sampling: Bob was the first S.S. Huebner
Fellow to receive a Ph.D. at the University of Pennsylvania. He was a
founder of the Risk Theory Seminar, editor of The Journal of Risk and
Insurance, president of the American Risk and Insurance Association, and
two-time winner of the prestigious Elizur Wright Award for outstanding
contributions to the insurance literature.
In order to honor this remarkable individual, we invited essays
in a call for papers that appeared in the Journal of Risk and Insurance and
in a letter that was sent to 20 scholars in the field. We received 13
submissions. The eight essays chosen for this volume encompass the
economic and financial theory of insurance, insurer and corporate risk
management, and insurance regulation. These essays will be of broad
interest to researchers in the area of insurance economics, finance, and
risk management. Many of the essays will also be of interest to
practitioners. Bob's fascination with risk and insurance was seemingly
limitless. The far ranging nature of these essays is commensurate with
the scope of Bob's interests.
The essay by Michael Smith and Stephen Kane reexamines and
provides new insights into the fundamental theory of risk reduction
through insurance. Neil Doherty and James Garven extend the theory of
the corporate demand for insurance and its relation to capital structure
decisions. The contribution by David Babbel and David Klock focuses on
measuring the interest rate risk of property-casualty insurer liabilities, an
important issue in insurer risk management and solvency regulation.
Joan Schmit, Kendall Roth, and Rick Winch provide survey evidence
illustrating the globalization of corporate risk management, a subject that
has become increasingly important in recent years.
The remaining four essays address important public policy issues.
S. Travis Pritchett considers whether significant gains in efficiency will be
likely if regulatory prohibitions on the sale and underwriting of insurance
by banks are relaxed. The contribution by the male co-editor considers
the political economy of compulsory automobile insurance laws, a subject
that has important implications for the efficiency and affordability of
automobile insurance. Patricia Danzon analyzes an important design
issue for no-fault automobile insurance (which was subject to earlier work
by Bob Mehr): whether personal injury protection coverage should be
primary in relation to individual and group health insurance. This issue
also has important implications for efficiency and affordability. In the
final essay, Stephen D'Arcy explores some of the adverse effects of
Preface ix
insurance on the growth in accident costs, including those that arise from
the relation between liability insurance and the legal system. The issues
addressed in this provocative essay are very important in view of
continuing consumer concern with and regulatory responses to chronic
growth in insurance costs.
We appreciate the administrative support of the 5.5. Huebner
Foundation and wish to thank J. David Cummins for helping to make
this project possible. Thanks are due Laurie Fitzpatrick, Jane Mayberry,
and Richard Phillips for assistance in preparing the final manuscript.
The world has been enriched by the many contributions of Bob
Mehr. Though he continues to be missed, his influence lives on through
his work and that of his many students. With this volume, we
acknowledge his influence in our lives and the debt we owe him for his
encouragement, his example, and his guidance.
With deepest gratitude,
Sandra G. Gustavson Scott E. Harrington
Athens, Ga. Columbia, S.c.
1
THE LAW OF LARGE NUMBERS
AND THE STRENGTH OF INSURANCE
Michael L. Smith
Department of Finance
Ohio State University
Stephen A. Kane
Department of Finance
University of Houston
1. Introduction
The law of large numbers (or the related central limit theorem)
is used in the literature on risk management and insurance to explain
pooling of losses as an insurance mechanism. Also called the "law of
averages", the principle holds that the average of a large number of
independent identically distributed random variables tends to fall close
to the expected value. This result can be used to show that the entry of
additional risks to an insured pool tends to reduce the variation of the
The authors acknowledge helpful suggestions from Robert Brown and
Boris Pittel of Ohio State University at an early stage of this project. Michael
Donahue provided valuable insights for the final version. These individuals
are not responsible for the paper's errors or conclusions.