CREDIT CRUNCH AND INSURANCE CONSUMPTION: THE AFTERMATH OF THE SUBPRIME MORTGAGE CRISIS

• Author: Shinichi Kamiya
• Date: 01 September 2018
• Published date: 01 September 2018
• DOI: http://doi.org/10.1111/jori.12167

CREDIT CRUNCH AND INSURANCE CONSUMPTION:THE

AFTERMATH OF THE SUBPRIME MORTGAGE CRISIS

Shinichi Kamiya

ABSTRACT

Using cross-state panel data of the U.S. personal auto insurance premiums

from 2007 to 2012, this study provides evidence that consumer purchases of

insurance were reduced by more than expected from losses of risk exposure

during and after the subprime mortgage crisis. Analyses show that the credit

crunch of auto loans and a deterioration of net worth in housing resulting

from the bursting housing bubble contributed to the reduced consumption of

auto insurance. This result is robust even after controlling for associated

factors, such as the insurance price, personal spending on vehicles, and

general consumption. These findings provide evidence for a real effect of the

financial crisis.

INTRODUCTION

Financial crises tend to disproportionally reduce insurance purchases in postcrisis

periods. For instance, the real private auto insurance premium per capita (density) in

the United States fell over the subprime mortgage crisis and remained at 88 percent of

the 2006 base year in 2012.

1,2

This long-lasting postcrisis trend sharply contrasts the

quick recovery of output, which was below the 2006 base year but only in 2009. A

further decline in the premium level after 2009 also suggests that the trend in

insurance consumption could not be explained by the general economic slowdown

measured by the recession that ended in June 2009.

3

Shinichi Kamiya is in the Nanyang Business School at the Nanyang Technological University,

Singapore. Shinichi Kamiya can be contacted via e-mail: skamiya@ntu.edu.sg. The author is

grateful to the Insurance Risk and Finance Research Centre (IRFRC) at Nanyang Business

School for its financial support.

1

The 2007–2009 U.S. subprime crisis is considered a credit crisis with a banking panic (see, e.g.,

Gorton, 2009).

2

The premium level represents inflation-adjusted direct premiums written per capita. Premium

data are taken from the NAIC annual statement from various years, and the GDP, population

and inflation data are obtained from the Bureau of Economic Analysis (BEA).

3

The U.S. subprime mortgage crisis began with the bursting of the housing bubble from its 2006

peak, and it caused a recession that started in 2007. The NBER determined that the recession

began in December 2007 and ended in June 2009. The recession lasted 18 months.

© 2016 The Journal of Risk and Insurance. Vol. 85, No. 3, 721–747 (2018).

DOI: 10.1111/jori.12167

721

It is also observed that the shock of the crisis on insurance consumption is

geographically very diverse in that the postcrisis premium levels fell as low as 76–77

percent in Arizona, Hawaii, Massachusetts, and Nevada but were mostly unaffected

in some states, such as Oklahoma and Texas. The contraction in the premium volume

was most pronounced in states that had a combination of high household debt and

larger declines in house prices (Arizona, California, Florida, and Nevada). This

finding is consistent with the literature that highlights the geographic distribution of

housing wealth shocks in explaining the large and unequal decline in consumption

from 2006 to 2009 (Mian, Rao, and Sufi, 2013).

The decline in nonlife insurance consumption after the U.S. subprime mortgage crisis

was also reported by the National Association of Insurance Commissioners (NAIC;

2008). The survey reports that 8 percent of respondents made changes to their auto

insurance policies (i.e., by reducing coverage, falling behind on payments or

canceling policies) and that 6 percent made changes to their homeowner policies

(with 4 percent canceling their policies).

4

The following NAIC survey, which was

conducted in 2011, asked individuals about any car-related lifestyle changes that

affected their car insurance premiums in the previous 12 months (NAIC, 2011). The

results are summarized as follows. More than half of the respondents saved on car

insurance premiums by reducing their coverage and/or switching to a cheaper policy

without changing coverage. Close to 40 percent of the respondents drove less (and/or

took public transportation more frequently). Approximately 20 percent of car owners

reduced the value or the number of their vehicles. Approximately 20 percent of

drivers reduced their car insurance coverage. Thus, the subprime mortgage crisis and

the following recession reduced not only the exposure to risks but also the degree of

auto insurance coverage.

These findings suggest several interesting empirical questions. The first question is

whether the large decline in auto insurance consumption can be fully explained by the

consumer purchase of vehicles (i.e., exposure to loss) dropping by 23 percent during

the 2007–2009 recession period.

5

If the loss in auto insurance premiums cannot be

explained by the consumer purchase of vehicles, the next question would be to

determine the contributing factors that are associated with the marginal decline in

insurance consumption in the postcrisis period. Our primary interest is the marginal

effect of three factors: income, housing wealth, and auto credit. The first two factors

are motivated by the theoretical prediction that the household purchase of insurance

is expected to be positively related to both income and household wealth (Rampini

and Viswanathan, 2015) as well as the marginal propensity to consume (MPC) out of a

wealth shock, which implies the following: (1) consumption responds to the shock on

net worth and (2) the consumption of low-wealth households responds more

aggressively to changes in wealth (Mian, Rao, and Sufi, 2013). The third factor, auto

4

The survey results had a significance level of 5 percent.

5

This large decline was determined by the author’s calculation based on state-level personal

expenditure data taken from the Bureau of Economic Analysis (BEA). Johnson, Pence, and

Vine (2014) also find that household vehicle purchases fell by more than 20 percent during the

period.

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