Could we rely on market discipline as a substitute for insurance regulation?

Fernando Castagnolo (Citigroup, London, UK)
Gustavo Ferro (Instituto de Economía, UADE and CONICET, Universidad Argentina de la Empresa, Buenos Aires, Argentina)

Journal of Financial Regulation and Compliance

ISSN: 1358-1988

Publication date: 15 February 2013

Abstract

Purpose

The purpose of this paper is to examine empirically whether the market discipline works, and if so, whether it is a complement or substitute of prudential regulation in the insurance markets. Market discipline is intended as “the power of … market forces … to evaluate and control the risky behaviour of the financial institutions”. The authors' formal hypothesis is that if market discipline works as complementary to prudential regulation, the response of the insured is expected to be weaker than if market discipline acts as a substitute to prudential regulation.

Design/methodology/approach

The authors designed an experiment examining policy subscription reaction to adjustments in insurers' risk ratings in three different regulatory environments, to compare market discipline in each market. An econometric model was estimated to test the reaction of policy subscription to changes in credit ratings of the insurers.

Findings

The findings indicate that more market discipline was exerted in the crisis period, and more intensely where it is intended to replace regulation. A formal hypothesis was tested: in a less regulated environment, consumers' protection rests more heavily on their caution and use of market information about the insurers' financial condition.

Research limitations/implications

The research is constrained by the availability and detail of the publicly available data.

Practical implications

The results imply that regulation and market discipline work more as complements than as substitutes.

Social implications

Market discipline does not replace prudential regulation in the insurance market.

Originality/value

The approach presented in the paper adds to precedent work studying comparatively different regulatory environments, and also concerns the response of market discipline in the financial crisis context.

Keywords

Citation

Castagnolo, F. and Ferro, G. (2013), "Could we rely on market discipline as a substitute for insurance regulation?", Journal of Financial Regulation and Compliance, Vol. 21 No. 1, pp. 4-15. https://doi.org/10.1108/13581981311297795

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Publisher

:

Emerald Group Publishing Limited

Copyright © 2013, Emerald Group Publishing Limited

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