Advantageous Selection in Insurance Markets with Compound Risk

Rachel Huang, Arthur Snow () and Larry Y. Tzeng ()
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Arthur Snow: University of Georgia
Larry Y. Tzeng: National Taiwan University

The Geneva Risk and Insurance Review, 2017, vol. 42, issue 2, No 4, 192 pages

Abstract: Abstract Building on the model of insurance contracting with hidden knowledge of risk class introduced by Rothschild and Stiglitz (1976), we assume that insurance applicants fail to reduce compound lotteries. In contrast with the adverse selection equilibrium identified by Rothschild and Stiglitz, in which coverage and expected claims frequency are positively correlated, we show that an advantageous selection equilibrium is possible, with coverage and expected claims frequency being negatively correlated. Whereas previous theories explain advantageous selection by adding a hidden action or a second dimension of hidden knowledge, our analysis shows that advantageous selection can arise solely as a consequence of insurance applicants’ attitude toward bearing compound risks.

Keywords: Adverse selection; Advantageous selection; Increasing aversion to second-stage risk (search for similar items in EconPapers)
JEL-codes: D82 G22 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (3)

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DOI: 10.1057/s10713-017-0023-6

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