Efficiency of Competition in Insurance Markets with Adverse Selection

CORE Discussion Paper No. 2005/54

30 Pages Posted: 30 Jun 2006

See all articles by Giuseppe De Feo

Giuseppe De Feo

University of Strathclyde, Glasgow - Strathclyde Business School - Department of Economics; University of Pavia - Department of Political Economy and Quantitative Methods

Jean Hindriks

University of London - School of Economics and Finance

Date Written: August 2005

Abstract

There is a general presumption that competition is a good thing. In this paper we show that competition in the insurance markets can be bad when there is adverse selection. Using the dual theory of choice under risk, we are able to fully characterize both the competitive and the monopoly market outcomes. When there are two types of risk, the monopoly dominates competition if and only if competition leads to market travelling. When there are a continuum of types the efficiency of competition is less trivial. In effect monopoly is shown to provide better insurance but at the cost of driving out some agents from the market. Performing simulation for different distributions of risk, we find that monopoly in general performs (much) better than competition in terms of the realization of the gains from trade across all traders in equilibrium. The reason is that the monopolist can exploit its market power to relax the incentive constraints.

Keywords: monopoly, competition, non-expected utility, insurance, adverse selection

JEL Classification: G22, G82

Suggested Citation

De Feo, Giuseppe and Hindriks, Jean, Efficiency of Competition in Insurance Markets with Adverse Selection (August 2005). CORE Discussion Paper No. 2005/54, Available at SSRN: https://ssrn.com/abstract=912234 or http://dx.doi.org/10.2139/ssrn.912234

Giuseppe De Feo

University of Strathclyde, Glasgow - Strathclyde Business School - Department of Economics ( email )

Sir William Duncan Building
130 Rottenrow
Glasgow, G4 0GE
United Kingdom
+44 (0)141 548 4075 (Phone)

HOME PAGE: http://www.strath.ac.uk/economics/staff/defeogiuseppedr/

University of Pavia - Department of Political Economy and Quantitative Methods ( email )

27100 Pavia
Italy

Jean Hindriks (Contact Author)

University of London - School of Economics and Finance ( email )

Mile End Road
London, E1 4NS
United Kingdom
+44 20 7882 7807 (Phone)
+44 20 8983 3580 (Fax)

HOME PAGE: http://www.dc.eclipse.co.uk/hindriks.html

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