Private Information and its Effect on Market Equilibrium: New Evidence from Long-Term Care Insurance

48 Pages Posted: 10 Sep 2003 Last revised: 5 Nov 2010

See all articles by Amy Finkelstein

Amy Finkelstein

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Kathleen M. McGarry

University of California, Los Angeles (UCLA) - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: September 2003

Abstract

This paper examines the standard test for asymmetric information in insurance markets: that its presence will result in a positive correlation between insurance coverage and risk occurrence. We show empirically that while there is no evidence of this positive correlation in the long-term care insurance market, asymmetric information still exists. We use individuals' subjective assessments of the chance they will enter a nursing home, together with the insurance companies' own assessment, to show that individuals do have private information about their risk type. Moreover, this private information is positively correlated with insurance coverage. We reconcile this direct evidence of asymmetric information with the lack of a positive correlation between insurance coverage and risk occurrence by demonstrating the existence of other unobserved characteristics that are positively related to coverage and negatively related to risk occurrence. Specifically, we find that more cautious individuals are both more likely to have long-term care insurance and less likely to enter a nursing home. Our results demonstrate that insurance markets may suffer from asymmetric information, and its negative efficiency consequences, even if those with more insurance are not higher risk. The results also suggest an alternative approach to testing for asymmetric information in insurance markets.

Suggested Citation

Finkelstein, Amy and McGarry, Kathleen M., Private Information and its Effect on Market Equilibrium: New Evidence from Long-Term Care Insurance (September 2003). NBER Working Paper No. w9957. Available at SSRN: https://ssrn.com/abstract=441590

Amy Finkelstein (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Kathleen M. McGarry

University of California, Los Angeles (UCLA) - Department of Economics ( email )

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