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 players interact. We adopt this approach to study regulation in insurance markets. A regulator restricts the menus of contracts a firm is allowed to offer, the firm offers a permitted menu to each agent, and agents choose contracts from their menus. Under a risk-ordering condition, the regulator can implement her first-best allocation using a collection of two-option menus. Several extensions explore the robustness of this result, illustrating the broad applicability of our framework.

Keywords: Regulation design, insurance, deviation contract

JEL Classification: D82, D47