THE CASCADE EFFECT IN INSURANCE PRICING

Lloyd's of London uses a cooperative, sequential technique for pricing and accepting large risks. The cascade model, developed to explain in itial public offering prices, is applicable to this form of pricing. T his article applies the cascade model to insurance to explain the hist oric and recent Lloyd's experience. Although the cascade model predict s that Lloyd's method of pricing would lead to above average profits i n the long run, the probability of bouts of severe underpricing under this system is also much higher than in a competitive market. Thus, th e recent pattern of Lloyd's profitability fits the cascade model.