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Insurance, self-control, and contract flexibility

Heiner Schumacher

European Economic Review, 2016, vol. 83, issue C, 220-232

Abstract: We study a competitive insurance market in which some consumers have too optimistic expectations regarding their future use of preventive measures. When contracts are long-term and inflexible, such naive consumers would increase the costs of insurance for low-risk consumers. The competitive insurance market therefore offers flexible contracts that allow for switching between different tariffs. Sophisticated consumers choose a partial insurance tariff and remain low-risks. Naive consumers choose the same tariff, but later switch to full insurance, and become high-risks. If there are sufficiently many naive consumers, they pay a transfer to sophisticated consumers (so that high-risks subsidize low-risks). In contrast, there are no such transfers when contracts are short-term. The model generates novel implications for the time frame of insurance contracts and insurance requirements.

Keywords: Insurance; Moral hazard; Hyperbolic discounting; Sophistication (search for similar items in EconPapers)
JEL-codes: D82 D91 G22 (search for similar items in EconPapers)
Date: 2016
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Handle: RePEc:eee:eecrev:v:83:y:2016:i:c:p:220-232