The Relationship Between Regulatory Pressure and Insurer Risk Taking

Authors

  • Wen-Chang Lin,

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    • Wen-Chang Lin is an associate professor in the Department of Finance, National Chung Cheng University, Taiwan. Yi-Hsun Lai is an assistant professor in the Department of Finance, National Yunlin University of Science and Technology, Taiwan. Michael R. Powers is a professor in the Department of Finance, Tsinghua University, and on leave from the Department of Risk Management and Insurance, Temple University. Wen-Chang Lin can be contacted via e-mail: finwcl@ccu.edu.tw.
  • Yi-Hsun Lai,

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    • Wen-Chang Lin is an associate professor in the Department of Finance, National Chung Cheng University, Taiwan. Yi-Hsun Lai is an assistant professor in the Department of Finance, National Yunlin University of Science and Technology, Taiwan. Michael R. Powers is a professor in the Department of Finance, Tsinghua University, and on leave from the Department of Risk Management and Insurance, Temple University. Wen-Chang Lin can be contacted via e-mail: finwcl@ccu.edu.tw.
  • Michael R. Powers

    Search for more papers by this author
    • Wen-Chang Lin is an associate professor in the Department of Finance, National Chung Cheng University, Taiwan. Yi-Hsun Lai is an assistant professor in the Department of Finance, National Yunlin University of Science and Technology, Taiwan. Michael R. Powers is a professor in the Department of Finance, Tsinghua University, and on leave from the Department of Risk Management and Insurance, Temple University. Wen-Chang Lin can be contacted via e-mail: finwcl@ccu.edu.tw.

Abstract

The article examines the risk-taking behavior of property–liability insurers in the presence of risk-based capital regulation. An option pricing model is developed to evaluate the expected regulatory cost and predict a nonlinear relationship between regulatory pressure and insurers’ risk taking. We then conduct an empirical test using the simultaneous threshold regression. The result shows that there is a threshold effect of regulatory pressure on insurer risk taking. Poorly capitalized insurers seem to be aware of their proximity to regulatory interventions but do not fully respond to the impending regulatory pressure. This implies either regulatory interventions are not costly enough or they are too late, or both.

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