Insurance Contracts with Adverse Selection When the Insurer Has Ambiguity about the Composition of the Consumers

Mingli Zheng (), Chong Wang and Chaozheng Li
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Chong Wang: Department of Economics, University of Macau
Chaozheng Li: Department of Economics, University of Kansas

Annals of Economics and Finance, 2016, vol. 17, issue 1, 179-206

Abstract: In this paper, we consider the optimal contract in a monopolistic insurance market when the insurer has ambiguity about the composition of the con-sumers. When there are only two types of consumers, we find that high-risk consumers are fully insured, whereas low-risk consumers are only partially in-sured. For an ambiguity averse insurer, as ambiguity increases, the optimal menu of contracts moves toward the one that equalizes the profits earned by the insurer from the two types of consumers. The insurer may offer the same menu of contracts even if her prior belief changes. For an ambiguity seeking insurer, when the degree of ambiguity increases, the optimal menu moves away from the menu that equalizes the profits earned from the two types of consumers.

Keywords: Adverse selection; Monopoly; Insurance; Ambiguity; ε-contaminated prior (search for similar items in EconPapers)
JEL-codes: D42 D82 (search for similar items in EconPapers)
Date: 2016
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