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May someone explain what cause the insolvent based on this passage?

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  • luie1168e
    Last edited by luie1168e; July 13 2012, 12:57 AM.

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  • Irish Blues
    This is a very simplified example, but should illustrate the point of the statement. Say for a given line of business in a state, each policy has expected losses of $100 and expenses of $25. The premium that needs to be charged is at least $125 [ignoring investment income]. If everyone is charging $150 to earn a suitable rate of return, there's a chance that someone will cut their rate to $149 to try and increase market share; that might prompt someone else to go to $148, someone else to go to $145, and suddenly a price war has started. Let's say someone starts charging $110 in this price war; while that one insurer may grab market share, they're underpricing what they know to be the cost of the policy and likely to be losing money as a result. If losses suddenly come in higher than expected [severe storms, major accident, unexpected liability, etc.] then that insurer may not have enough capital to pay out the losses incurred. That causes it to become insolvent.

    Meanwhile, everyone is paying into the guaranty fund in case someone goes insolvent. As the price war was ongoing, someone else either tried to low-ball as well [pricing at $125] trying to hold market share, or had capital get depleted through loss of market share, inopportune investments, ... whatever. When the 1st insurer becomes insolvent, everyone else has to kick in to try and make claimants whole; if another company has been weakened and doesn't have the funds to contribute, it runs the risk of becoming insolvent as well - and the resulting burden has to be carried by the other remaining insurers. If claimants cannot be paid off in full, this can [will] spark outrage from the public who will want to ensure that insurers can't behave recklessly by engaging in price wars that inevitably hurt policyholders.

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  • May someone explain what cause the insolvent based on this passage?

    Based on this passage, i have some question

    "if not careful, competition with insufficient regulation could lead to price wars where in a competitive market some insurers could low‐ball prices, greatly expand market share, and then go insolvent, which could lead to other insurers going insolvent (via guaranty association
    fees). Demand by the public for overly strict regulation may then be implemented."

    Why expand market share could make a company goes insolvent? Also, why guaranty assciation fees make some of other company insolvent?