The effect of rate regulation on price dispersion in the United States automobile insurance market

Empirical evidence on the price of automobile insurance suggests that there are significant differences in prices across firms. The purpose of this study is to explain the variability of prices using a theoretical model of price dispersion. The model identifies costly consumer search and differences in firm-specific cost structures as potential sources of price dispersion. Its applicability is tested separately for the private passenger physical damage and liability lines through the use of weighted least squares regression analysis of the dispersion of prices in all states over a period of seven years (1980 to 1986). The ability to categorize state-level methods of rate regulation as either competitive or noncompetitive allows also for analysis of the impact of regulation on price dispersion in the statewide auto insurance markets. The principal finding is that price dispersion in the physical damage line is explained at high levels of significance by the model, although its relevance to the market for auto liability insurance is unsupported by the empirical analysis. In addition, rate regulation appears to significantly reduce the level of price dispersion in the physical damage line