The evolution of insurance markets under adverse selection

Andrew Sellgren

Journal of Evolutionary Economics, 2001, vol. 11, issue 5, 526 pages

Abstract: This paper applies a floating-point genetic algorithm to an insurance model in which the principals who underwrite insurance contracts cannot observe the risk characteristics of the agents who sign those contracts. Under perfect rationality, the equilibria of this model are analogous to those in Rothschild and Stiglitz (1976). The learning version of the model exhibits interesting transition dynamics as well as novel outcomes. When the learning model converges to the equilibrium from the model with perfect rationality, pooling contracts break down over time and the set of contracts bifurcates, with one group of principals serving high-risk agents and another group serving low-risk agents. When there are relatively few low-risk agents in the market, the economy converges to contracts that provide full insurance for high-risk agents, while low-risk agents are not served at all. When there are relatively few high-risk agents in the market, some types of pooling contracts are sustainable. These last two results are at odds with the outcomes under models of perfect rationality.

Keywords: Genetic; algorithm; -; Insurance; -; Adverse; selection; -; Screening (search for similar items in EconPapers)
Date: 2002-01-18
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