Pooling and Separating Equilibria in Insurance Markets with Adverse Selection and Distribution Costs&ast

Marie Allard (), Jean-Paul Cresta and Jean Rochet
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Marie Allard: Ecole des Hautes Etudes Commerciales (HEC), 3000, chemin de la Côte-Sainte-Catherine, Montreal, Quebec, Canada H3T 2A7.
Jean-Paul Cresta: IDEI, GREMAQ, LEA (University of Toulouse le Mirail)

The Geneva Risk and Insurance Review, 1997, vol. 22, issue 2, 103-120

Abstract: In the Rothschild-Stiglitz [1976] model of a competitive insurance market with adverse selection, pooling equilibria cannot exist. However in practice, pooling contracts are frequent, notably in health insurance and life insurance. This is due to the fact that distribution costs are nonnegligible and increase rapidly when more contracts are offered. We modify accordingly the Rothschild-Stiglitz model by introducing such distribution costs. We find that, however small these costs may be, they entail possible existence of pooling equilibria. Moreover, in these pooling equilibria, it is the high-risk individuals who are rationed, in the sense that they would be willing to buy more insurance at the current premium/insurance ratio. The Geneva Papers on Risk and Insurance Theory (1997) 22, 103–120. doi:10.1023/A:1008664000457

Date: 1997
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