Adverse Selection in Insurance Markets

Georges Dionne (), Neil Doherty and Nathalie Fombaron
Additional contact information
Neil Doherty: University of Pennsylvania
Nathalie Fombaron: Université de Paris X-Nanterre

No 00-5, Working Papers from HEC Montreal, Canada Research Chair in Risk Management

Abstract: In this survey we present some of the more significant results in the literature on adverse selection in insurance markets. Sections 1 and 2 introduce the subject and section 3 discusses the monopoly model developed by Stiglitz (1977) for the case of single-period contracts and extended by many authors to the multi-period case. The introduction of multi-period contracts raises many issues that are discussed in detail : time horizon, discounting, commitment of the parties, contract renegotiation and accidents underreporting. Section 4 covers the literature on competitive contracts. The analysis becomes more complicated since insurance companies must take into account competitive pressures when they set incentives contracts. As pointed out by Rothschild and Stiglitz (1976), there is not necessarily a Cournot-Nash equilibrium in presence of adverse selection. However, market equilibrium can be sustained when principals anticipate competitive reactions to their behaviour or when they adopt strategies that differ from the pure Nash strategy. Multi-period contracting is discussed. We show that different predictions on the evolution of insurer profits over time can be obtained from different assumptions concerning the sharing of information between insurers about individual's choice of contracts and accidents experience. The roles of commitment and renegotiation between the parties to the contract are important. Section 5 introduces models that consider moral hazard and adverse selection simultaneously and section 6 treats adverse selection when people can choose their risk status. Section 7 discusses many extensions to the basic models such as risk categorization, di§erent risk aversion, symmetric imperfect information, multiple risks, principals more informed than agents and uberrima fides.

Keywords: Adverse selection; insurance markets; monopoly; competitive contracts; self-selection mechanisms; single-period contracts; multi-period contracts; commitment; contract renegotiation; accidents underreporting; risk categorization (search for similar items in EconPapers)
JEL-codes: D80 D81 G22 (search for similar items in EconPapers)
Pages: 66 pages
Date: 2000-03-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Related works:
Working Paper: Adverse Selection in Insurance Markets (2000)
Working Paper: Adverse Selection in Insurance Markets (2000)
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