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Repeated Insurance Contracts and Learning

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  • Thomas R. Palfrey
  • Chester S. Spatt

Abstract

This article considers a repeated insurance model with incomplete information in which the insurer and the consumer both learn over time about the unknown risk category of the consumer. Care choices by young consumers affect the informational value of the accident history. Under an optimal scheme of long-term insurance contracts, young consumers will always be "subsidized" by old consumers, and consumers who are reassessed as low-risk types are always subsidizers (i.e., reverse experience ratings). We compare this optimal scheme with the set of contracts that would emerge in a competitive market if only short-term contracting were possible. These sequentially competitive contracts can lead to over-investment in care by both young and old consumers, relative to the optimum, in contrast to the underinvestment problem associated with moral hazard in insurance.

Suggested Citation

  • Thomas R. Palfrey & Chester S. Spatt, 1985. "Repeated Insurance Contracts and Learning," RAND Journal of Economics, The RAND Corporation, vol. 16(3), pages 356-367, Autumn.
    • Handle: RePEc:rje:randje:v:16:y:1985:i:autumn:p:356-367
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    Cited by:

    1. Dionne, G. & Doherty, N., 1991. "Adverse Selection In Insurance Markets: A Selective Survey," Cahiers de recherche 9105, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
    2. Ruo Jia & Zenan Wu, 2019. "Insurer commitment and dynamic pricing pattern," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 44(1), pages 87-135, March.
    3. Nilssen, Tore, 2000. "Consumer lock-in with asymmetric information," International Journal of Industrial Organization, Elsevier, vol. 18(4), pages 641-666, May.
    4. Ruo Jia & Zenan Wu, 2019. "Insurer commitment and dynamic pricing pattern," The Geneva Papers on Risk and Insurance Theory, Springer;International Association for the Study of Insurance Economics (The Geneva Association), vol. 44(1), pages 87-135, March.
    5. Mayer, Chris & Piskorski, Tomasz & Tchistyi, Alexei, 2013. "The inefficiency of refinancing: Why prepayment penalties are good for risky borrowers," Journal of Financial Economics, Elsevier, vol. 107(3), pages 694-714.
    6. Dehlen, Tobias & Zellweger, Thomas & Kammerlander, Nadine & Halter, Frank, 2014. "The role of information asymmetry in the choice of entrepreneurial exit routes," Journal of Business Venturing, Elsevier, vol. 29(2), pages 193-209.
    7. Dionne, Georges & Fombaron, Nathalie & Doherty, Neil, 2012. "Adverse selection in insurance contracting," Working Papers 12-8, HEC Montreal, Canada Research Chair in Risk Management.

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