Risk Classification in Insurance Markets with Risk and Preference Heterogeneity

57 Pages Posted: 14 Jul 2021

See all articles by Vitor Farinha Luz

Vitor Farinha Luz

University of British Columbia (UBC)

Piero Gottardi

University of Essex; Centre for Economic Policy Research (CEPR)

Humberto Moreira

FGV EPGE

Date Written: June 2021

Abstract

This paper studies a competitive model of insurance markets in which consumers are privately informed about their risk and risk preferences. We provide a tractable characterization of equilibria, which depend non-trivially on consumers' type distribution, a desirable feature for policy analysis. The use of consumer characteristics for risk classification is modeled as the disclosure of a public informative signal. A novel monotonicity property of signals is shown to be necessary and sufficient for their release to be welfare improving for almost all consumer types. We also study the effect of changes to the risk distribution in the population as the result of demographic changes or policy interventions. When considering the monotone likelihood ratio ordering of distributions, an increase in the risk distribution leads to lower utility for almost all consumer types. In contrast, the effect is ambiguous when considering the first order stochastic dominance ordering.

JEL Classification: D82, G22, I13, I18

Suggested Citation

Farinha Luz, Vitor and Gottardi, Piero and Moreira, Humberto, Risk Classification in Insurance Markets with Risk and Preference Heterogeneity (June 2021). CEPR Discussion Paper No. DP16310, Available at SSRN: https://ssrn.com/abstract=3886783

Vitor Farinha Luz (Contact Author)

University of British Columbia (UBC) ( email )

2329 West Mall
Vancouver, British Columbia BC V6T 1Z4
Canada

Piero Gottardi

University of Essex ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Humberto Moreira

FGV EPGE ( email )

Praia de Botafogo
190/1100
Rio de Janeiro
Brazil

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