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Porrini, Donatella --- "Insurance Regulation" [2012] ELECD 444; in Van den Bergh, J. Roger; Pacces, M. Alessio (eds), "Regulation and Economics" (Edward Elgar Publishing, 2012)

Book Title: Regulation and Economics

Editor(s): Van den Bergh, J. Roger; Pacces, M. Alessio

Publisher: Edward Elgar Publishing

ISBN (hard cover): 9781847203434

Section: Chapter 12

Section Title: Insurance Regulation

Author(s): Porrini, Donatella

Number of pages: 29

Extract:

12 Insurance regulation
Donatella Porrini



1. INTRODUCTION

Insurance can be defined as an instrument for managing and coping with risk.
Given the existence of a probability that a future loss will actually occur,
insurance replaces the uncertainty of a loss occurring in exchange for a
premium, which can be thought of as a guaranteed and known small loss to
prevent a large, and possibly devastating, loss.1
Following Abraham (1995), insurance plays three economic functions. The
first function is risk transfer: the risk is transferred from a risk-averse individ-
ual to the risk-neutral insurer.2 The second function is risk pooling. By insur-
ing numerous policyholders, the "uncertainty" of the individual insured is
converted by the insurer's "certainty" that this risk will occur to some of its
customers. The third function is risk allocation: the price each insured party
pays should reflect the risk he contributes.
Given the overall outcome of the three above-mentioned economic func-
tions, insurance contracts enhance social welfare, while at the same time
inducing people to take cost-justified precautions, internalizing damage.
Furthermore, insurance encourages the risk-averse insured party to make
investments that they would not make otherwise. Meanwhile, life insurance
plays a role as a long-term investment and savings instrument (Shavell, 1982
and 2000).
The insurance business has become highly important to society's prosper-
ity and development and the importance of the insurance industry has led
legislators to heavily regulate this sector.
This regulation includes competition policy, as ...