Asymmetric Information and Learning: Evidence from the Automobile Insurance Market

Abstract

This paper tests the predictions of adverse selection models using data from the automobile insurance market. I find that, in contrast to what recent research has suggested, the evidence is consistent with the presence of informational asymmetries in this market: new customers choosing higher insurance coverage are associated with more accidents. Consistent with the presence of learning by policyholders about their risk type, such a coverage-accident correlation exists only for policyholders with three or more years of driving experience prior to joining their insurer. The informational advantage that new customers with driving experience have over the insurer appears to arise in part from under-reporting of past claim history. I find evidence that policyholders switching to new insurers are disproportionately ones with a poor claims history and that new customers under-report their past claims history when joining a new insurer.

Keywords: Asymmetric information, adverse selection, screening, sorting, moral hazard, insurance, deductible, learning, information transmission, repeat customers

JEL Classification: D40, D80, D82, D83, L10, G22