Separating equilibria in insurance markets: A new theoretical perspective

19 Jun 2017

Dr David Rowell (CBEH) will be presenting “Separating equilibria in insurance markets: A new theoretical perspective”, a paper co-authored with Professor Zweifel (University of Zurich, Switzerland) to the 46th Australian Conference of Economists (ACE), Sydney (July 19-21, 2017) and the 44th Annual Seminar European Group of Risk and Insurance Economics (EGRIE), London (September 18-20, 2017).  

Abstract

The objective of this paper is to prepare the theoretical ground for more ample research into the behaviour of consumers and insurance companies in the presence of adverse selection. As noted by Mimra and Wambach (2014), there has been little progress in testing the importance of adverse selection and the prevalence of separating vs. pooling equilibria. The proposed way forward is to model consumers in their search for maximum coverage at a given premium and insurers in their effort to stave off high risks (and attract low ones). Reaction functions are derived for the two players giving rise to Nash equilibria in efforts space, which typically are separating between high and low risks. These equilibria are then projected into the wealth level space of the Rothschild-Stiglitz (1976) model. Moreover, displacements of the Nash equilibria due to (i) community rating of premiums, (ii) provision of information to consumers free of charge, and (iii) learning from loss experience by insurers are used to extend the set of empirically testable predictions beyond conventional approaches.

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