A Simple Test of Private Information in the Insurance Markets with Heterogeneous Insurance Demand

29 Pages Posted: 31 Jan 2011

See all articles by Li Gan

Li Gan

Texas A&M University - Department of Economics; National Bureau of Economic Research (NBER)

Feng Huang

Southwestern University of Finance and Economics (SWUFE)

Adalbert Mayer

Texas A&M University - Department of Economics

Date Written: January 2011

Abstract

A positive correlation between insurance coverage and ex post risk can be an indicator for private information in insurance markets. However, this test fails if agents have heterogeneous risk attitudes. We propose a new test that conditions on unobserved types of individuals who differ in their risks preferences. This makes it possible to detect asymmetric information without direct evidence of private information - even if agents have heterogeneous risk attitudes. We apply our technique to the market for long-term care insurance. Finkelstein and McGarry (2006) provide direct evidence for the existence of private information in this market. At the same time they fail to find a positive correlation between insurance coverage and ex post risk. Our method indicates the existence of private information, without using direct evidence of private information. Our methodology is applicable to other insurance markets and markets where proxies for private information are not available.

Suggested Citation

Gan, Li and Huang, Feng and Mayer, Adalbert, A Simple Test of Private Information in the Insurance Markets with Heterogeneous Insurance Demand (January 2011). NBER Working Paper No. w16738. Available at SSRN: https://ssrn.com/abstract=1749897

Li Gan (Contact Author)

Texas A&M University - Department of Economics ( email )

5201 University Blvd.
College Station, TX 77843-4228
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Feng Huang

Southwestern University of Finance and Economics (SWUFE) ( email )

55 Guanghuacun St,
Chengdu, Sichuan 610074
China

Adalbert Mayer

Texas A&M University - Department of Economics ( email )

5201 University Blvd.
College Station, TX 77843-4228
United States

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