Insurance Security System

Financial risk is a part of landscape of insurance business. Although serious regulation measures have been taken, the government can not prevent insurance companies from bankruptcy. With the soaring number of insolvency of insurers, the policy makers had to give more attention to designing a system, which can protect the insurance policy holders. The state guaranty fund systems were created in response to the increased number of insurer insolvency. While the guaranty fund concept was designed to provide claimants with some measure of protection against the costs of insurer insolvency, it developed a stable circumstance for the industry. While some guaranty funds have been established through legislation, which called explicit guaranty systems, some countries have chosen implicit method in which the insured has not been given the right to receive the reimbursement from guaranty fund. In contrast with implicit system, explicit guaranty system set detailed requirements on every respect of the protection process, thus, the insured can be very sure about what kind of protection and how soon he can get it if his insurer go bankrupt.This dissertation has four phases. First, theoretical discussions on fragile market of insurance and moral hazard problem in insurance guaranty system. The fragility of insurance market is considered as one of the direct reasons, which lead to the establishment of guaranty system. Because guaranty system can create an incentive for financial institutions to increase risk, moral hazard problem has to be taken into account. Second, discussing on the multi-function of guaranty system and comparing the effectiveness between explicit and implicit guaranty system. Third, introduce the framework of an explicit guaranty system and present the insurance guaranty fund in the United States as an example. Last, give some suggestions to build up insurance guaranty system in China. Main conclusion including:This article considers the behavior of market in the absence of guaranty funds using an abstract model of "market fragility" in which markets can fall into Pareto-inefficient equilibrium. In essence, a problem arises in many insurance purchasing process where the current action of the buyer (the insured) depend on anticipation of the future action by the seller (the insurer). Market fragility arises since the inability of insurer to commit to future actions that lead to the shocks on confidence or beliefs of consumers and can undermine the willingness of consumers to buy policies from insurer. Moreover, small changes in business condition can lead to large changes in the expectation of the insured, and result in the situation, which is similar to running the bank. Overall, the fragile insurance market can result in the failure of the parties to write efficient contracts, and can expose insurance policy holder to additional sources of uncertainty. The presence of this additional risk leads to the consideration of guaranty funds. This article provides sufficient conditions under which guarantee funds support the first-best allocation and hence eliminate market fragility. It is the limited liabilities but not the insurance guaranty system itself that lead to an incentive for insurance company to increase risk. The owners of the company have a put option on the firm's assets with a strike price equal to the value of the firm's liabilities. Simple option pricing comparative static demonstrates that the value of the put option is greater for riskier firms. The insurer is straightforward and follows directly from the asymmetric payoff structure of an option. If an insurer engages in risky activities and the outcome is favorable, then the firm's owners receive the benefit. If the outcome is unfavorable, the owner's liability is limited to the equity value of the firm, and any shortfall is absorbed by policyholders. Under guaranty system, the risk-taking incentive will be stronger. The riskier insurers can get more benefit from the fund and are not penalized for risk-taking through t...