Inverse Selection

44 Pages Posted: 21 May 2020 Last revised: 27 Jan 2022

See all articles by Markus K. Brunnermeier

Markus K. Brunnermeier

Princeton University - Department of Economics

Rohit Lamba

Pennsylvania State University - College of the Liberal Arts

Carlos Segura-Rodriguez

Central Bank of Costa Rica

Date Written: December 30, 2021

Abstract

Big data, machine learning and AI inverts adverse selection problems. It allows insurers to infer statistical information and thereby reverses information advantage from the insuree to the insurer. In a setting with two-dimensional type space whose correlation can be inferred with big data we derive three results: First, a novel tradeoff between a belief gap and price discrimination emerges. The insurer tries to protect its statistical information by offering only a few screening contracts. Second, we show in a setting with naïve agents that do not perfectly infer statistical information from the price of offered contracts, price discrimination significantly boosts insurer’s profits. Third, introducing competition sucks out the informational advantage of the insurer, and forcing the monopolistic insurer to reveal its statistical information can be helpful to the insuree even though it may reduce total surplus. We also discuss the significance of our analysis through four stylized facts: the rise of data brokers, the perils of market concentration with advent of big data, the importance of consumer activism and regulatory forbearance, and the merits of a public data repository.

Keywords: Insurance, Big Data, Informed Principal, Belief Gap, Price Discrimination

JEL Classification: G22, D82, D86, C55

Suggested Citation

Brunnermeier, Markus Konrad and Lamba, Rohit and Segura-Rodriguez, Carlos, Inverse Selection (December 30, 2021). Available at SSRN: https://ssrn.com/abstract=3584331 or http://dx.doi.org/10.2139/ssrn.3584331

Markus Konrad Brunnermeier

Princeton University - Department of Economics ( email )

Bendheim Center for Finance
Princeton, NJ
United States
609-258-4050 (Phone)
609-258-0771 (Fax)

HOME PAGE: http://www.princeton.edu/¡­markus

Rohit Lamba (Contact Author)

Pennsylvania State University - College of the Liberal Arts ( email )

University Park, PA 16802-3306
United States

HOME PAGE: http://www.rohitlamba.com

Carlos Segura-Rodriguez

Central Bank of Costa Rica ( email )

Apartado Postal 10058
1000 San Jose
United States

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