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Background Risk and the Performance of Insurance Markets under Adverse Selection

Author

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  • Keith J Crocker

    (Smeal College of Business, Pennsylvania State University, University Park, PA 16802, U.S.A.)

  • Arthur Snow

    (Department of Economics, University of Georgia, Athens, GA 30602, U.S.A.)

Abstract

Background risk can influence the performance of insurance markets that must deal with adverse selection when applicants are risk vulnerable, since they are more averse to bearing the insurable risk as a result of their exposures to background risk. We show that background risk always results in a lower deductible for the incentive constrained contract, and that a broader range of markets attains the stable sequential equilibrium cross-subsidized pair of separating contracts. We conclude that background risk always improves the performance of markets for coverage against (insurable) foreground risks that must deal with adverse selection. We also find, however, that these improvements are never sufficient to offset the cost to insureds of bearing the background risk. The Geneva Risk and Insurance Review (2008) 33, 137–160. doi:10.1057/grir.2008.12

Suggested Citation

  • Keith J Crocker & Arthur Snow, 2008. "Background Risk and the Performance of Insurance Markets under Adverse Selection," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 33(2), pages 137-160, December.
    • Handle: RePEc:pal:genrir:v:33:y:2008:i:2:p:137-160
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    Citations

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    Cited by:

    1. Dionne, Georges & Fombaron, Nathalie & Mimra, Wanda, 2023. "Adverse selection in insurance," Working Papers 23-5, HEC Montreal, Canada Research Chair in Risk Management.
    2. Gemmo, Irina & Browne, Mark J. & Gründl, Helmut, 2017. "Transparency aversion and insurance market equilibria," ICIR Working Paper Series 25/17, Goethe University Frankfurt, International Center for Insurance Regulation (ICIR).
    3. Gemmo, Irina & Kubitza, Christian & Rothschild, Casey, 2020. "Constrained efficient equilibria in selection markets with continuous types," Journal of Public Economics, Elsevier, vol. 190(C).
    4. Dionne, Georges & Fombaron, Nathalie & Doherty, Neil, 2012. "Adverse selection in insurance contracting," Working Papers 12-8, HEC Montreal, Canada Research Chair in Risk Management.
    5. Gemmo, Irina & Kubitza, Christian & Rothschild, Casey G., 2018. "The existence of the Miyazaki-Wilson-Spence equilibrium with continuous type distributions," ICIR Working Paper Series 32/18, Goethe University Frankfurt, International Center for Insurance Regulation (ICIR).
    6. Jean-François Outreville, 2014. "The Meaning of Risk? Insights from The Geneva Risk and Insurance Review," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 39(4), pages 768-781, October.

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