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Explaining Insurance Policy Provisions via Adverse Selection


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  • Virginia R. Young

    (School of Business, University of Wisconsin—Madison, Madison, WI 53706)

  • Mark J. Browne

    (School of Business, University of Wisconsin—Madison, Madison, WI 53706)

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    In this article, we show that common insurance policy provisions—namely, deductibles, coinsurance, and maximum limits—can arise as a result of adverse selection in a competitive insurance market. Research on adverse selection typically builds on the assumption that different risk types suffer the same size loss and differ only in their probability of loss. In this study, we allow the severity of the insurance loss to be random and, thus, generalize the results of Rothschild and Stiglitz [1976] and Wilson [1977]. We characterize the separating equilibrium contracts in a Rothschild-Stiglitz competitive market. By further assuming a Wilson competitive market, we show that an anticipatory equilibrium might be achieved by pooling, and we characterize the optimal pooling contract. The Geneva Papers on Risk and Insurance Theory (1997) 22, 121–134. doi:10.1023/A:1008616117296

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    Bibliographic Info

    Article provided by Palgrave Macmillan in its journal The Geneva Papers on Risk and Insurance Theory.

    Volume (Year): 22 (1997)
    Issue (Month): 2 (December)
    Pages: 121-134

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    Handle: RePEc:pal:genrir:v:22:y:1997:i:2:p:121-134

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    Postal: Palgrave Macmillan Journals, Subscription Department, Houndmills, Basingstoke, Hampshire RG21 6XS, UK

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    Cited by:
    1. Jeffrey R. Brown & Amy Finkelstein, 2008. "The Interaction of Public and Private Insurance: Medicaid and the Long-Term Care Insurance Market," American Economic Review, American Economic Association, American Economic Association, vol. 98(3), pages 1083-1102, June.
    2. Young, Virginia R., 1999. "Optimal insurance under Wang's premium principle," Insurance: Mathematics and Economics, Elsevier, vol. 25(2), pages 109-122, November.


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