An Empirical Examination of Information Barriers to Trade in Insurance

53 Pages Posted: 24 Sep 1996 Last revised: 30 Jun 2010

See all articles by John Cawley

John Cawley

Cornell University - College of Human Ecology, Department of Policy Analysis & Management (PAM); Cornell University - College of Arts & Sciences, Department of Economics; Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); National University of Ireland, Galway (NUIG) - J.E. Cairnes School of Business & Economics; NBER; IZA

Tomas Philipson

University of Chicago; National Bureau of Economic Research (NBER)

Date Written: July 1996

Abstract

This paper tests restrictions implied by the canonical theory of insurance under asymmetric information using ideal data that contains the self-perceived and actual mortality risk of individuals, as well as the price and quantity of their life insurance. We report several findings which are hard to reconcile with the canonical theory. First, we find a striking independence of self-perceived risk and the price of insurance. Second, we find strong evidence of the opposite type of non-linear pricing than predicted by theory: the theory predicts that prices rise with quantity, but we find that they fall. Third, we find that risk is negatively correlated with the quantity of insurance purchased although the theory predicts a positive correlation. Fourth, we find that a substantial fraction of individuals hold multiple insurance contracts, which casts doubt on the prediction that unit prices rise with quantity because multiple small contracts dominate a large one in such a case. Lastly, we test the accuracy of the self-perceived risk of the insured through estimating the induced profits they imply. We conclude by discussing the robustness of these results and the questions they raise for future theoretical models.

Suggested Citation

Cawley, John and Philipson, Tomas J., An Empirical Examination of Information Barriers to Trade in Insurance (July 1996). NBER Working Paper No. w5669. Available at SSRN: https://ssrn.com/abstract=4534

John Cawley (Contact Author)

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Tomas J. Philipson

University of Chicago ( email )

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