EconPapers    
Economics at your fingertips  
 

Does propitious selection explain why riskier people buy less insurance?

Philippe De Donder () and Jean Hindriks ()

No 2006032, CORE Discussion Papers from Université catholique de Louvain, Center for Operations Research and Econometrics (CORE)

Abstract: Empirical testing of asymmetric information in the insurance market has uncovered a negative correlation between risk levels and insurance purchases, rather than the positive correlation predicted by the standard insurance theory. Hemenway (1990) proposes an explanation for this negative correlation, called "propitious selection". He argues that potential insurance buyers have different tastes for risk and that "individuals who are highly risk avoiding are more likely both to try to reduce the hazard and to purchase insurance" (p. 1064). Chiappori and Salanié (2000) also suggest that this line of argument, which they call "cherry picking", may explain the observed negative correlation. In this paper, we show that the propitious selection argument does not imply negative correlation between risk levels and insurance purchases, because it fails to take into account the supply side of the insurance market. To illustrate this claim, we provide a model where, although we assume thatindividuals differ in risk aversion and that the more risk averse individuals exert more precaution and buy more insurance, we end up with a positive correlation between risk and insurance purchases at equilibrium. The reason is that, in any separating equilibrium, the more risk averse individuals face insurance overprovision which, combined with moral hazard, increases theirrisk relative to the less risk averse individuals. To obtain the negative correlation between risk and insurance purchases, one further needs the extra condition of decreasing marginal willingness to pay for the less risk averse individuals. Finally, we find that propitious selection has profound policy implications for social insurance.

Keywords: preference-based adverse selection; cherry picking; precaution; social insurance (search for similar items in EconPapers)
JEL-codes: D82 G22 (search for similar items in EconPapers)
Date: 2006-03
References: View references in EconPapers View complete reference list from CitEc
Citations View citations in EconPapers (2) Track citations by RSS feed

Downloads: (external link)
https://uclouvain.be/en/research-institutes/immaq/core/dp-2006.html (text/html)
Our link check indicates that this URL is bad, the error code is: 404 Not Found

Related works:
Working Paper: Does Propitious Selection Explain Why Riskier People Buy Less Insurance? (2006) Downloads
Working Paper: Does Propitious Selection Explain why Riskier People Buy less Insurance (2006) Downloads
Working Paper: Does Propitious Selection Explain why Riskier People buy less Insurance? (2006) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cor:louvco:2006032

Access Statistics for this paper

More papers in CORE Discussion Papers from Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) Voie du Roman Pays 34, 1348 Louvain-la-Neuve (Belgium). Contact information at EDIRC.
Bibliographic data for series maintained by Alain GILLIS ().

 
Page updated 2018-11-30
Handle: RePEc:cor:louvco:2006032