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The Problem of Asymmetric Information: A Simulation of How Insurance Markets Can Be Inefficient

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  • David L. Eckles
  • Martin Halek

Abstract

The concept of adverse selection is discussed in virtually all academic insurance textbooks. However, undergraduate students have rarely had the experience of purchasing insurance which may limit their ability to fully comprehend the market inefficiencies created by asymmetric information. We provide a classroom simulation of an insurance market that highlights the concept of adverse selection and its impact on the insurance industry. Participants are asked to make insurance decisions in pursuit of their own interests under different market conditions. In the absence of perfect information, participants actively observe that a socially optimal outcome does not occur.

Suggested Citation

  • David L. Eckles & Martin Halek, 2007. "The Problem of Asymmetric Information: A Simulation of How Insurance Markets Can Be Inefficient," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 10(1), pages 93-105, March.
    • Handle: RePEc:bla:rmgtin:v:10:y:2007:i:1:p:93-105
    DOI: j.1540-6296.2007.00108.x
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    References listed on IDEAS

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    1. Michael Rothschild & Joseph Stiglitz, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 90(4), pages 629-649.
    2. Charles A. Holt & Roger Sherman, 1999. "Classroom Games: A Market for Lemons," Journal of Economic Perspectives, American Economic Association, vol. 13(1), pages 205-214, Winter.
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    Cited by:

    1. Kevin M. Gatzlaff, 2013. "Three Practical Assignments for the Introductory Risk Management and Insurance Student," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 16(2), pages 281-294, September.
    2. John Garvey & Patrick Buckley, 2011. "Using Technology to Encourage Critical Thinking and Optimal Decision Making in Risk Management Education," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 14(2), pages 299-309, September.
    3. Kevin C. Ahlgrim & James R. Jones, 2014. "Insurance Rating Games: Strikes, Spares, and Bags," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 17(2), pages 297-313, September.
    4. Leon Chen & Puneet Jaiprakash, 2017. "An Insurance Market Simulation With Both Adverse and Advantageous Selection," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 20(1), pages 133-146, March.

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