Full Insurance, Bayesian Updated Premiums, and Adverse Selection

Richard Watt () and Francisco J. Vazquez ()
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Francisco J. Vazquez: [1] Departamento de Análisis Económico, Universidad Autónoma de Madrid, 28049-Madrid Spain.

The Geneva Risk and Insurance Review, 1997, vol. 22, issue 2, 135-150

Abstract: In the classic Rothschild-Stiglitz model of adverse selection in a competitive environment, we analyse a “no-claims bonus” type contract (bonus-malus). We show that, under full insurance coverage, if the insurance company applies Bayes's rule to learn about client probability types over time and uses this information in premium calculations for contract renewals, then there exist conditions under which all client types strictly prefer the Bayesian updating contract to the classic Rothschild-Stiglitz separating equilibrium. The Geneva Papers on Risk and Insurance Theory (1997) 22, 135–150. doi:10.1023/A:1008668101366

Date: 1997
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