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Risk Classification in Insurance Markets with Risk and Preference Heterogeneity

Author

Listed:
  • Vitor Farinha Luz
  • Piero Gottardi
  • Humberto Moreira

Abstract

This paper studies a competitive model of insurance markets in which consumers are privately informed about their risk and risk preferences. We provide a characterization of the equilibria, which depend non-trivially on consumers’ type distribution, a desirable feature for policy analysis. The use of consumer characteristics for risk classification is modeled as the disclosure of a public informative signal. A novel property of signals, monotonicity, is shown to be necessary and sufficient for their release to be welfare improving for almost all consumer types. We also study the effect of changes to the risk distribution in the population as the result of demographic changes or policy interventions. We show that an increase in the risk distribution, according to the monotone likelihood ratio ordering of distribution, leads to lower utility for almost all consumer types. In contrast, the effect is ambiguous when considering the first-order stochastic dominance ordering.

Suggested Citation

  • Vitor Farinha Luz & Piero Gottardi & Humberto Moreira, 2023. "Risk Classification in Insurance Markets with Risk and Preference Heterogeneity," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 90(6), pages 3022-3082.
    • Handle: RePEc:oup:restud:v:90:y:2023:i:6:p:3022-3082.
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    File URL: http://hdl.handle.net/10.1093/restud/rdad017
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    Keywords

    Adverse selection; Asymmetric information; Insurance; Regulation;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • I13 - Health, Education, and Welfare - - Health - - - Health Insurance, Public and Private
    • I18 - Health, Education, and Welfare - - Health - - - Government Policy; Regulation; Public Health

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