Price Cutting in Liability Insurance Markets

This article analyzes alleged underpricing of general liability insurance prior to the mid-1980s liability insurance crisis. The theoretical analysis considers whether moral hazard and/or heterogeneous information for forecasting claim costs can cause some firms to price too low and depress other firms' prices. Cross-sectional analysis of insurer loss forecast revisions (which should be greater for firms with low prices caused by moral hazard or heterogeneous information) and premium growth provides evidence consistent with low pricing due to moral hazard but not heterogeneous information. The evidence also implies that shifts in the loss distribution produced large industrywide forecast errors.