Competitive Insurance Markets and Adverse Selection in the Lab

Abstract

We provide an experimental analysis of competitive insurance markets with adverse selection. Our parameterised version of the lemons' model of Akerlof in the insurance context predicts total crowding-out of low risks when insurers offer a single full insurance contract. The therapy proposed by Rothschild and Stiglitz consists of adding a partial insurance contract so as to obtain self-selection of risks. We test the theoretical predictions of these two models in two experiments. A clean test is obtained by matching the parameters of these experiments and by controlling for the risk neutrality of insurers and the common risk aversion of their clients by means of the binary lottery procedure. The results reveal a partial crowding-out of low risks in the first experiment. Crowding-out is not eliminated in the second experiment and it is not even significantly reduced. Finally, instead of the predicted separating equilibrium, we find pooling equilibria. The latter can be sustained because insureds who objectively differ in their risk level do not perceive themselves as being so much different.

Insurance demand experiments: Comparing crowdworking to the lab

“…For example, insurance consumers often have private information about their risk, which can manifest into an adverse selection problem for insurance pools. This has been experimentally investigated with subjects in the laboratory (Riahi et al, 2013) and online (Zhang & Palma, 2021). No study has tested whether these samples differ in their use of private information, and so their results cannot be directly compared.…”

How is the trade-off between adverse selection and discrimination risk affected by genetic testing? Theory and experiment

“…The 20 tasks are obtained by crossing the 4 values of K ((2,4,6 and 8) corresponding to (y/18, 2y/18, 3y/18 and 4y/18)) with the 5 values of f (0,0.25,0.5,0.75 and 1). Some of these parameters have more extreme values than in other insurance-motivated lab experiments (e.g., in Riahi et al (2013) where the wealth at risk ratio d/y is 0.2 and the high-risk probability p H is 3/10). Given the small values of φ and K, this is necessary to induce meaningful variations across choices within a task.…”

“…This is not possible in model ( 4), since we have 66 dichotomous variables that capture participants' fixed effects. 31 Hence, we compute the marginal effects for each participant and report in Table 2 the average marginal effect of f and K on the probability of testing in Q1 and Q2.…”

Hypothetical Surveys and Experimental Studies of Insurance Demand: A Review

“…The other third offered multiple possible insurance contracts to choose from. These can, for example, vary by coinsurance rate (as in Papon ) or by deductible (as in Riahi et al., ). Using multiple choice options can serve two purposes.…”

“…Riahi et al. () use it to induce CARA preferences for buyers in an insurance market with asymmetric information to test theoretical predictions derived from said preferences. While this can be a worthwhile exercise, studies of insurance demand with induced preferences (as in Lypny ) offer little insight into actual behavior.…”