Experimental evidence on coverage choices and contract prices in the market for corporate insurance (original) (raw)

Adverse Selection in Insurance Contracting

SSRN Electronic Journal, 2012

In this survey we present some of the more signi…cant results in the literature on adverse selection in insurance markets. Sections 1 and 2 introduce the subject and Section 3 discusses the monopoly model developed by Stiglitz (1977) for the case of single-period contracts extended by many authors to the multi-period case. The introduction of multi-period contracts raises many issues that are discussed in detail; time horizon, discounting, commitment of the parties, contract renegotiation and accidents underreporting. Section 4 covers the literature on competitive contracts. The analysis is more complicated because insurance companies must take into account competitive pressures when they set incentive contracts. As pointed out by Rothschild and Stiglitz (1976), there is not necessarily a Cournot-Nash equilibrium in the presence of adverse selection. However, market equilibrium can be sustained when principals anticipate competitive reactions to their behavior or when they adopt strategies that di¤er from the pure Nash strategy. Multi-period contracting is discussed. We show that di¤erent predictions on the evolution of insurer pro…ts over time can be obtained from di¤erent assumptions concerning the sharing of information between insurers about individual's choice of contracts and accident experience. The roles of commitment and renegotiation between the parties to the contract are important. Section 5 introduces models that consider moral hazard and adverse selection simultaneously and Section 6 covers adverse selection when people can choose their risk status. Section 7 discusses many extensions to the basic models such as risk categorization, multidimensional adverse selection, symmetric imperfect information, reversed or double-sided adverse selection, principals more informed than agents, uberrima …des and participating contracts.

Evidence of adverse selection in automobile insurance markets

1999

In this paper, we propose an empirical analysis of the presence of adverse selection in an insurance market. We first present a theoretical model of a market with adverse selection and we introduce different issues related to transaction costs, accident costs, risk aversion and moral hazard. We then discuss an econometric modeling based on latent variables and we derive its relationship with specification tests that may be useful to isolate the presence of adverse selection in the portfolio of an insurer. We discuss in detail the relationship between our modeling and that of Puelz and Snow (1994). Finally, we present some empirical results derived from a different data set. We show that there is no residual adverse selection in the studied portfolio since appropriate risk classification is made by the insurer. Consequently, the insurer does not need a selfselection mechanism such as the deductible choice to reduce adverse selection.

Empirical Evidence for Advantageous Selection in the Insurance Market

2000

  1. indicated that individuals with a higher degree of risk aversion would demand more insurance and invest in self-protection to reduce risk probability when both the preference type and investment in self-protection are hidden from insurers. They referred to the negative correlation between market insurance and risk type as advantageous selection. However, the relationship between risk type and the degree of risk aversion is debatable in both theoretical and empirical research. This paper therefore proposes that advantageous selection could be supported from another angle by directly examining the relationships that exist among market insurance, selfprotection, and risk probability. By focusing on the commercial fire insurance market, information on the purchase of market insurance, investment in self-protection, and fire accident records is hand-collected by means of a unique survey. It is found that firms purchasing market insurance have a greater tendency to channel efforts into selfprotection. It is also found that firms expending effort on self-protection are less likely to suffer a fire accident. Furthermore, it is found that firms with commercial fire insurance have less chance of suffering a fire accident than those without such insurance. Each of the above three findings jointly supports the view that advantageous selection could play a critical role in the commercial fire insurance market.

(Non-)Insurance Markets, Loss Size Manipulation and Competition - Experimental Evidence

SSRN Electronic Journal, 2016

The common view that buyer power of insurers may effectively counteract provider market power critically rests on the idea that consumers and insurers have a joint interest in extracting price concessions. However, in markets where the buyer is an insurer, the interests of insurers and consumers to reduce prices may be importantly misaligned. The positive dependence between loss size and the insurer's expected profits limits the insurer's incentives to reign in loss sizes; in markets with small initial loss sizes, insurers may try to raise these in order to create demand for insurance. After having defined insurance and non-insurance markets based on the initial loss size, we develop theory to show that insurers with buyer power have incentives to create insurance markets. Insurer competition will push their profits to zero but markets do not return to the initial non-insurance state. This constitutes a welfare loss. We design experimental insurance markets to test our theory and find support. Monopolistic insurer-subjects in non-insurance markets increase loss sizes to establish insurance markets. Insurer competition eliminates profits but not the loss size to uninsured consumers. This provides an additional reason to be careful in granting insurers buyer power.

An Insurance Market Simulation With Both Adverse and Advantageous Selection

Risk management and insurance review, 2017

The theory of adverse selection predicts that high-risk individuals are more likely to buy insurance than low-risk individuals if asymmetric information regarding individuals' risk type is present in the market. The theory of advantageous selection predicts the opposite-a negative relationship between insurance coverage and risk type can be obtained when hidden knowledge in other dimensions (e.g., the degree of risk aversion) is present in addition to the risk type. Using the heterogeneity of insurance buyers in either risk type or risk aversion, we first introduce a classroom-based insurance market simulation game to show that adverse selection and advantageous selection can coexist. We then explain the underlying concepts using two methods: a mathematical framework based on expected utility theory and an empirical framework based on the results of the game itself. The game is easy to implement, reinforces textbook concepts by providing students a hands-on experience, and supplements current textbooks by bringing their content up to date with current research.

Adverse Selection in Insurance Markets

2000

In this survey we present some of the more signi…cant results in the literature on adverse selection in insurance markets. Sections 1 and 2 introduce the subject and section 3 discusses the monopoly model developed by for the case of single-period contracts and extended by many authors to the multiperiod case. The introduction of multi-period contracts raises many issues that are discussed in detail : time horizon, discounting, commitment of the parties, contract renegotiation and accidents underreporting. Section 4 covers the literature on competitive contracts. The analysis becomes more complicated since insurance companies must take into account competitive pressures when they set incentives contracts. As pointed out by , there is not necessarily a Cournot-Nash equilibrium in presence of adverse selection. However, market equilibrium can be sustained when principals anticipate competitive reactions to their behaviour or when they adopt strategies that di¤er from the pure Nash strategy. Multi-period contracting is discussed. We show that di¤erent predictions on the evolution of insurer pro…ts over time can be obtained from di¤erent assumptions concerning the sharing of information between insurers about individual's choice of contracts and accidents experience. The roles of commitment and renegotiation between the parties to the contract are important. Section 5 introduces models that consider moral hazard and adverse selection simultaneously and section 6 treats adverse selection when people can choose their risk status. Section 7 discusses many extensions to the basic models such as risk categorization, di¤erent risk aversion, symmetric imperfect information, multiple risks, principals more informed than agents and uberrima …des.

An evolutionary analysis of insurance markets with adverse selection

Games and Economic Behavior, 2002

Rothschild and Stiglitz (1976) demonstrated that adverse selection may entail nonexistence of equilibrium in competitive insurance markets. We approach this problem in a dynamic model with boundedly rational insurance rms. Firms' behavior is based on imitation of pro t making contracts, withdrawal of loss making contracts, and experimentation with random contracts. Consumers choose in each period the best contract available. We show that the candidate competitive equilibrium is the long run prediction if experimentation is rare and every rm experiments with contracts in the vicinity of its current menu.

Efficiency of Competition in Insurance Markets with Adverse Selection

SSRN Electronic Journal, 2000

There is a general presumption that competition is a good thing. In this paper we show that competition in the insurance markets can be bad when there is adverse selection. Using the dual theory of choice under risk, we are able to fully characterize both the competitive and the monopoly market outcomes. When there are two types of risk, the monopoly dominates competition if and only if competition leads to market unravelling. When there are a continuum of types the e¢ ciency of competition is less trivial. In e¤ect monopoly is shown to provide better insurance but at the cost of driving out some agents from the market. Performing simulation for di¤erent distributions of risk, we …nd that monopoly in general performs (much) better than competition in terms of the realization of the gains from trade across all traders in equilibrium. The reason is that the monopolist can exploit its market power to relax the incentive constraints.

Selection in Insurance Markets: Theory and Empirics in Pictures

Journal of Economic Perspectives, 2011

We present a graphical framework for analyzing both theoretical and empirical work on selection in insurance markets. We begin by using this framework to review the "textbook" adverse selection environment and its implications for insurance allocation, social welfare, and public policy. We then discuss several important extensions to this classical treatment that are necessitated by important real world features of insurance markets and which can be easily incorporated in the basic framework. Finally, we use the same graphical approach to discuss the intuition behind recently developed empirical methods for testing for the existence of selection and examining its welfare consequences. We conclude by discussing some important issues that are not well-handled by this framework and which, perhaps not unrelatedly, have been little addressed by the existing empirical work.