The Legal Constraint of Misrepresentation in Insurance Market and its Impact on Insurance Contracts

33 Pages Posted: 19 Aug 2015

See all articles by Yu Huang

Yu Huang

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Shinichi Kamiya

Nanyang Technological University (NTU) - Nanyang Business School

Joan T. Schmit

University of Wisconsin - Madison - Department of Actuarial Science, Risk Management and Insurance

Date Written: July 1, 2015

Abstract

We advance the literature starting from the work by Dixit (2000), who considers the effect of the principle of good faith on adverse selection. Introducing a post-loss risk misrepresentation testing in a competitive insurance market model, we identify a sufficient condition to guarantee that a market equilibrium exists which is unique and characterized by a set of separating full coverage contracts if the test for misrepresentation is sufficiently accurate. We further investigate the case that the full-coverage equilibrium is not attained. Specifically, we show: (1) how the easiness of the post-loss test would impact the insurance contract, and (2) that the market equilibrium approximates the first-best under feasible conditions, which tend to be satisfied by the intrinsic nature of insurance contracts. Lastly, we describe the insurance contract after the introduction of a post-loss test given the use of underwriting, and show that the post-loss test completely takes the place of underwriting when either or both of the tests can be chosen.

Keywords: misrepresentation, good faith, adverse selection, insurance

JEL Classification: D81, D82, G22

Suggested Citation

Huang, Yu and Kamiya, Shinichi and Schmit, Joan T., The Legal Constraint of Misrepresentation in Insurance Market and its Impact on Insurance Contracts (July 1, 2015). Available at SSRN: https://ssrn.com/abstract=2646514 or http://dx.doi.org/10.2139/ssrn.2646514

Yu Huang

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Shinichi Kamiya (Contact Author)

Nanyang Technological University (NTU) - Nanyang Business School ( email )

Singapore, 639798
Singapore

Joan T. Schmit

University of Wisconsin - Madison - Department of Actuarial Science, Risk Management and Insurance ( email )

Madison, WI
United States
608-262-4240 (Phone)

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