We find that stock returns move in the direction of insurer rating changes in the 12-month period prior to the announcement. There is an additional stock price response following the announcement of a downgrade, but no response to upgrade announcements. The reaction to a downgrade is more pronounced when it involves a smaller insurer, when it spans multiple levels, or when it is a threshold downgrade. Returns are significantly more negative during the 12 months leading up to a downgrade announcement during the financial crisis (2008 and 2009) compared to other sample years.

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The theory of adverse selection predicts that high-risk individuals are more likely to buy insurance than low-risk individuals if asymmetric information regarding individuals' risk type is present in the market. The theory of advantageous selection predicts the opposite-a negative relationship between insurance coverage and risk type can be obtained when hidden knowledge in other dimensions (e.g., the degree of risk aversion) is present in addition to the risk type. Using the heterogeneity of insurance buyers in either risk type or risk aversion, we first introduce a classroom-based insurance market simulation game to show that adverse selection and advantageous selection can coexist. We then explain the underlying concepts using two methods: a mathematical framework based on expected utility theory and an empirical framework based on the results of the game itself. The game is easy to implement, reinforces textbook concepts by providing students a hands-on experience, and supplements current textbooks by bringing their content up to date with current research.