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Large losses and equilibrium in insurance markets

Author

Listed:
  • Lisa L. Posey

    (Smeal College of Business, Pennsylvania State University)

  • Paul D. Thistle

    (University of Nevada, Las Vegas)

Abstract

We show that if losses are larger than wealth, then individuals with the option of declaring bankruptcy will not insure if the loss probability is above a threshold. In an insurance market with adverse selection, if the high risks’ loss probability is above the threshold, then no trade occurs at the Rothschild–Stiglitz equilibrium. Active trade in insurance requires cross-subsidization. When a subset of individuals with significant costs of bankruptcy and default is included in the market, then the equilibrium outcome always involves positive levels of insurance coverage for some individuals, but the parameters of the model determine whether all types receive coverage, or whether null contracts are received by both high and low risks with no bankruptcy costs or just the low risks from that group.

Suggested Citation

  • Lisa L. Posey & Paul D. Thistle, 2019. "Large losses and equilibrium in insurance markets," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 44(2), pages 222-244, September.
    • Handle: RePEc:pal:genrir:v:44:y:2019:i:2:d:10.1057_s10713-019-00038-8
    DOI: 10.1057/s10713-019-00038-8
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    References listed on IDEAS

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    Cited by:

    1. Ben‐jiang Ma & Jing‐yu Ye & Geng Liu & Yuan‐ji Huang, 2020. "Adverse selection, limited compensation, and the design of environmental liability insurance contract in the case of enterprise bankruptcy," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 41(7), pages 1327-1337, October.
    2. Posey, Lisa L. & Thistle, Paul D., 2021. "Genetic testing and genetic discrimination: Public policy when insurance becomes “too expensive”," Journal of Health Economics, Elsevier, vol. 77(C).

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    More about this item

    Keywords

    Adverse selection; Contracts; No trade;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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