Adverse Selection in Insurance Contracting

74 Pages Posted: 22 Aug 2012

See all articles by Georges Dionne

Georges Dionne

HEC Montreal - Department of Finance

Nathalie Fombaron

Université Paris X Nanterre

Neil A. Doherty

University of Pennsylvania - Insurance & Risk Management Department; University of Pennsylvania - Business & Public Policy Department

Date Written: August 20, 2012

Abstract

In this survey we present some of the more signi…ficant results in the literature on adverse selection in insurance markets. Sections 1 and 2 introduce the subject and Section 3 discusses the monopoly model developed by Stiglitz (1977) for the case of single-period contracts extended by many authors to the multi-period case. The introduction of multi-period contracts raises many issues that are discussed in detail; time horizon, discounting, commitment of the parties, contract renegotiation and accidents underreporting. Section 4 covers the literature on competitive contracts. The analysis is more complicated because insurance companies must take into account competitive pressures when they set incentive contracts. As pointed out by Rothschild and Stiglitz (1976), there is not necessarily a Cournot-Nash equilibrium in the presence of adverse selection. However, market equilibrium can be sustained when principals anticipate competitive reactions to their behavior or when they adopt strategies that differ from the pure Nash strategy. Multi-period contracting is discussed. We show that different predictions on the evolution of insurer pro…ts over time can be obtained from different assumptions concerning the sharing of information between insurers about individual’s choice of contracts and accident experience. The roles of commitment and renegotiation between the parties to the contract are important. Section 5 introduces models that consider moral hazard and adverse selection simultaneously and Section 6 covers adverse selection when people can choose their risk status. Section 7 discusses many extensions to the basic models such as risk categorization, multidimensional adverse selection, symmetric imperfect information, reversed or double-sided adverse selection, principals more informed than agents, uberrima …des and participating contracts.

Keywords: Adverse selection, insurance markets, monopoly, competitive contracts, self-selection mechanisms, single-period contracts, multi-period contracts, commitment, contract renegotiation, accident underreporting, risk categorization, participating contracts

JEL Classification: D80, D81, G22

Suggested Citation

Dionne, Georges and Fombaron, Nathalie and Doherty, Neil A., Adverse Selection in Insurance Contracting (August 20, 2012). Available at SSRN: https://ssrn.com/abstract=2132555 or http://dx.doi.org/10.2139/ssrn.2132555

Georges Dionne (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-6596 (Phone)
514-340-5019 (Fax)

HOME PAGE: http://www.hec.ca/gestiondesrisques/

Nathalie Fombaron

Université Paris X Nanterre ( email )

92, av. de la République, Nanterre
Room G301, Building G
Paris, Nanterre Cedex 92001
France

Neil A. Doherty

University of Pennsylvania - Insurance & Risk Management Department ( email )

Philadelphia, PA 19104-6365
United States
215-898-7652 (Phone)
215-898-0310 (Fax)

University of Pennsylvania - Business & Public Policy Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

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