Explaining Insurance Policy Provisions via Adverse Selection

Virginia R. Young and Mark J. Browne
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Virginia R. Young: School of Business, University of Wisconsin—Madison, Madison, WI 53706
Mark J. Browne: School of Business, University of Wisconsin—Madison, Madison, WI 53706

The Geneva Risk and Insurance Review, 1997, vol. 22, issue 2, 134 pages

Abstract: In this article, we show that common insurance policy provisions—namely, deductibles, coinsurance, and maximum limits—can arise as a result of adverse selection in a competitive insurance market. Research on adverse selection typically builds on the assumption that different risk types suffer the same size loss and differ only in their probability of loss. In this study, we allow the severity of the insurance loss to be random and, thus, generalize the results of Rothschild and Stiglitz [1976] and Wilson [1977]. We characterize the separating equilibrium contracts in a Rothschild-Stiglitz competitive market. By further assuming a Wilson competitive market, we show that an anticipatory equilibrium might be achieved by pooling, and we characterize the optimal pooling contract. The Geneva Papers on Risk and Insurance Theory (1997) 22, 121–134. doi:10.1023/A:1008616117296

Date: 1997
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