Journal of Risk and Uncertainty, 10:143-156 (1995) 9 1995 Kluwer Academic Publishers Guaranteed Renewability in Insurance MARK V. PAULY Health Care Systems Department, The Wharton School, University of Pennsylvania, Philadelphia, PA 19104 HOWARD KUNREUTHER Operations & Information Management Department, The Wharton School, University of Pennsylvania, Philadelphia, PA 19104 RICHARD HIRTH Department of Health Management and Policy, University of Michigan, Ann Arbor, MI 48109-2029 Abstract We propose a guaranteed renewability (GR) insurance in which a sequence of premiums would enable insurers to break even and would be chosen by both low- and high-risk buyers, whether or not they had suffered a loss. The premium schedule would continually decline over time, as the insurer collects more information to determine who the low-risk buyers are. The highest premiums are charged initially to protect the insurer if low-risk individuals leave for the spot market. The concluding portion of the article discusses the limitations of a GR policy in the health and environmental liability area, the most serious being instability in estimates of underlying loss trends. Key words: uncertainty, insurance, renewability, competition Introduction Insurances of many types typically cover some risk for a limited time period. For in- stance, health insurance contracts conventionally provide coverage against loss for a year, although longer and shorter terms are possible. Over that time period, the pre- mium is known with certainty. At the beginning of the next period, however, the factors which determine the level of the premium that an insurance purchaser is charged may change. The probability of loss may change, or the amount of the loss may also change. In particular, the person is subject to the risk that the premium at the beginning of the second year may be higher or lower than in the previous one. In some cases, the change in premium can be dramatic. In the case of indMdual health insurance, for example, the discovery of an indicator of chronic disease can cause a person's insurance premiums to jump substantially. Sudden jumps in premiums because of changes in perceived risk levels are less characteristic of other policies, but they do happen for liability and automobile insurance. In fact, in some situations, such as envi- ronmental pollution, the next period's premium may be so high that it is equivalent to not