Adverse Selection with the Boot on the Other Foot: Insurer Insolvency as a Problem in Asymmetric Information

Yuechen Dai and Richard Watt ()
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Richard Watt: University of Canterbury, https://www.canterbury.ac.nz

Working Papers in Economics from University of Canterbury, Department of Economics and Finance

Abstract: The problem of insurer insolvency has almost exclusively been seen as an issue in regulation. However, it is also clear that there is an obvious element of asymmetric information present when insolvency is possible. Insurers are clearly better informed of their probability of defaulting on an insurance arrangement than are their insureds, and just as clearly, that probability affects the value of the contract to the insured. With that in mind, we recast the issue of insurer insolvency within the context of asymmetric information, specifically, adverse selection. In our model, the (risk-neutral) insurer is the informed agent, and the (risk-averse) policyholder is the uninformed principal. Thereby, the classic player identities in an asymmetric information problem are reversed. We find equilibrium contract menus for the cases of perfect competition between insurers, and for the case of a single monopolistic insurer.

Keywords: Insurance insolvency; asymmetric information; adverse selection (search for similar items in EconPapers)
JEL-codes: D80 D82 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2023-03-01
New Economics Papers: this item is included in nep-cta, nep-des and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:cbt:econwp:23/02

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