Regulation Design in Insurance Markets

Abstract

Regulators often impose rules that constrain the behavior of market participants. We propose a new framework in which to study optimal regulation, representing the policy choice as a delegation problem overlaying a mechanism design problem: a regulator chooses a set of permitted mechanisms to influence how a mechanism designer and other agents interact. We adopt this approach to study regulation in insurance markets. A regulator restricts the menus of contracts an informed firm is allowed to offer, the firm offers a permitted menu to each consumer, and consumers choose contracts from offered menus. Under an ordering on consumer types and firm information, the regulator can fully leverage the firm's information by forcing the firm to offer specified additional options on each menu. Several extensions illustrate the applicability of our framework.

Keywords: Regulation design, insurance, deviation contract

JEL Classification: D82, D47