Dynamic investment-driven insurance pricing and optimal regulation

Abstract

This paper analyzes the competitive equilibrium of insurance market in a dynamic setting, focusing on the interaction between insurers' underwriting and investment strategies. Three possible equilibrium outcomes are identified: a positive insurance market, a zero insurance market, and market failure. Our findings reveal why insurers may rationally accept underwriting losses by setting a negative safety loading while relying on investment profits, particularly when there is a negative correlation between insurance gains and financial returns. Such losses can still occur even when the insurance market is monopolistic. Additionally, we explore the impact of regulatory frictions, showing that while imposing a cost on investment can enhance social welfare under certain conditions, it may not always be necessary.