Separating Equilibria with Search and Selection Effort: Evidence from the Auto Insurance Market

David Rowell () and Peter Zweifel
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David Rowell: Center for the Business and Economics of Health (CBEH), School of Economics, The University of Queensland, St Lucia, Brisbane 4067, Australia
Peter Zweifel: Department of Economics, University of Zurich, Rämistr. 71, 8006 Zurich, Switzerland

JRFM, 2024, vol. 17, issue 4, 1-25

Abstract: The objective of this paper is to assess the behavior of policyholders and insurance companies in the presence of adverse selection by accounting for costly search and selection efforts, respectively. Insurers seek to stave off high-risk types, while consumers are hypothesized to maximize coverage at a given premium. Reaction functions are derived for the two players giving rise to Nash equilibria in efforts space, which are separating almost certainly regardless of the share of low risks in the market. Empirical evidence from the Australian market for automobile insurance is analyzed using Structural Equation Modeling. Convergence has been achieved with both the developmental and test samples. Both consumer search and insurer selection are found to be positively correlated with risk type, providing a good measure of empirical support for the theoretical model.

Keywords: adverse selection; separating equilibria; consumer search effort; insurer selection effort; automobile insurance (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2024
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