Severity Risk and the Adverse Selection of Frequency Risk

J. OF RISK AND INSURANCE, Vol. 62 No. 4, December 1995

Posted: 3 Jul 1998

See all articles by Neil A. Doherty

Neil A. Doherty

University of Pennsylvania - Insurance & Risk Management Department; University of Pennsylvania - Business & Public Policy Department

Harris Schlesinger

University of Alabama; CESifo (Center for Economic Studies and Ifo Institute)

Abstract

This article shows how the introduction of severity risk into a simple model of insurance markets affects the optimal level of insurance. Also examined is how severity risk affects the equilibrium for an insurance market exhibiting adverse selection in the frequency risk. Individuals are assumed to possess identical loss severity distributions, but differ in their privately-known probabilities of having a loss. In particular, the effects of severity risk on the Nash equilibrium of Rothschild and Stiglitz (1976), on the anticipatory equilibrium of Wilson (1977), and on Miyazaki's (1977) extension of Wilson's equilibrium are analyzed. Severity risk is shown to affect the type of equilibrium contracts (pooling vs. separating), equilibrium levels of coverage, and overall societal welfare.

JEL Classification: G22

Suggested Citation

Doherty, Neil A. and Schlesinger, Harris, Severity Risk and the Adverse Selection of Frequency Risk. J. OF RISK AND INSURANCE, Vol. 62 No. 4, December 1995. Available at SSRN: https://ssrn.com/abstract=7116

Neil A. Doherty

University of Pennsylvania - Insurance & Risk Management Department ( email )

Philadelphia, PA 19104-6365
United States
215-898-7652 (Phone)
215-898-0310 (Fax)

University of Pennsylvania - Business & Public Policy Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

Harris Schlesinger (Contact Author)

University of Alabama ( email )

P.O. Box 870244
200 Alston Hall, Box 870224
Tuscaloosa, AL 35487
United States
205-348-7858 (Phone)
205-348-0590 (Fax)

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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