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Multidimensional Private Information, Market Structure and Insurance Markets

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  • Hanming Fang

    (Department of Economics, University of Pennsylvania)

  • Zenan Wu

    (Department of Economics, Peking University)

Abstract

A large empirical literature found that the correlation between insurance purchase and ex post realization of risk is often statistically insignificant or negative. This is inconsistent with the predictions from the classic models of insurance a la Akerlof (1970), Pauly (1974) and Rothschild and Stiglitz (1976) where consumers have one-dimensional heterogeneity in their risk types. It is suggested that selection based on multidimensional private information, e.g., risk and risk preference types, may be able to explain the empirical findings. In this paper, we systematically investigate whether selection based on multidimensional private information in risk and risk preferences, can, under different market structures, result in a negative correlation in equilibrium between insurance coverage and ex post realization of risk. We show that if the insurance market is perfectly competitive, selection based on multidimensional private information does not result in negative correlation property in equilibrium, unless there is a sufficiently high loading factor. If the insurance market is monopolistic or imperfectly competitive, however, we show that it is possible to generate negative correlation property in equilibrium when risk and risk preference types are sufficiently negative dependent, a notion we formalize using the concept of copula. We also clarify the connections between some of the important concepts such as adverse/advantageous selection and positive/negative correlation property.

Suggested Citation

  • Hanming Fang & Zenan Wu, 2016. "Multidimensional Private Information, Market Structure and Insurance Markets," PIER Working Paper Archive 16-016, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 18 Oct 2016.
  • Handle: RePEc:pen:papers:16-016
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    References listed on IDEAS

    as
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    5. Liran Einav & Amy Finkelstein & Mark R. Cullen, 2010. "Estimating Welfare in Insurance Markets Using Variation in Prices," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 125(3), pages 877-921.
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    16. 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.
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    Cited by:

    1. Levy, Yehuda John & Veiga, Andre, 2020. "On the existence of positive equilibrium profits in competitive screening markets," Games and Economic Behavior, Elsevier, vol. 124(C), pages 140-168.
    2. de Meza, David & Reito, Francesco & Reyniers, Diane, 2021. "Too much trade: The hidden problem of adverse selection," Journal of Public Economics, Elsevier, vol. 204(C).
    3. Roy McGee, 2023. "Adverse Selection Among Early Adopters and Unraveling Innovation," University of Western Ontario, Centre for Human Capital and Productivity (CHCP) Working Papers 2022302, University of Western Ontario, Centre for Human Capital and Productivity (CHCP).
    4. Hanming Fang & Ami Ko, 2018. "Partial Rating Area Offering in the ACA Marketplaces: Facts, Theory and Evidence," NBER Working Papers 25154, National Bureau of Economic Research, Inc.
    5. Heski Bar-Isaac & Ian Jewitt & Clare Leaver, 2021. "Adverse selection, efficiency and the structure of information," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 72(2), pages 579-614, September.
    6. Karlsson, Martin & Klohn, Florian & Rickayzen, Ben, 2018. "The role of heterogeneous parameters for the detection of selection in insurance contracts," Insurance: Mathematics and Economics, Elsevier, vol. 83(C), pages 110-121.
    7. Capatina, Elena, 2020. "Selection in employer sponsored health insurance," Journal of Health Economics, Elsevier, vol. 71(C).
    8. Daniel Bauer & Jochen Russ & Nan Zhu, 2020. "Asymmetric information in secondary insurance markets: Evidence from the life settlements market," Quantitative Economics, Econometric Society, vol. 11(3), pages 1143-1175, July.
    9. R. Anton Braun & Karen A. Kopecky & Tatyana Koreshkova, 2017. "Old, Frail, and Uninsured: Accounting for Puzzles in the U.S. Long-Term Care Insurance Market," FRB Atlanta Working Paper 2017-3, Federal Reserve Bank of Atlanta.
    10. De La Mata, Dolores & Olivella, Pau & Valdés, Maria Nieves, 2022. "Asymmetric Information with multiple risks: the case of the Chilean Private Health Insurance Market," UC3M Working papers. Economics 35441, Universidad Carlos III de Madrid. Departamento de Economía.
    11. de Meza, David & Reito, Francesco & Reyniers, Diane, 2021. "Too much trade: A problem of adverse selection," MPRA Paper 107084, University Library of Munich, Germany.
    12. Casey Rothschild & Paul D. Thistle, 2022. "Supply, demand, and selection in insurance markets: Theory and applications in pictures," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 25(4), pages 419-444, December.
    13. Liran Einav & Amy Finkelstein, 2023. "Empirical analyses of selection and welfare in insurance markets: a self-indulgent survey," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 48(2), pages 167-191, September.

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    More about this item

    Keywords

    Asymmetric Information; Multidimensional Private Information; Adverse Selection; Advantageous Selection; Positive Correlation Property;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • I11 - Health, Education, and Welfare - - Health - - - Analysis of Health Care Markets

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