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Competitive Screening in Insurance Markets with Endogenous Labor Supply

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  • Nick Netzer
  • Florian Scheuer
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    Abstract

    We examine equilibria in competitive insurance markets when individuals take unobservable labor supply decisions. Precautionary labor motives intro-duce countervailing incentives in the insurance market, and equilibria with positive profits can occur even in the standard case in which individuals exogenously differ in risk only. We then extend the model to allow for both privately known risks and labor productivities. This endogenously introduces two-dimensional heterogeneity in the insurance market since precautionary labor effects lead to differences in income and hence risk aversion. Under these circumstances, separating and pooling equilibria exist, which generally differ from those with exogenous two-dimensional heterogeneity considered by the existing literature. Notably, in contrast to standard screening models, profits may be increasing with insurance coverage, and the correlation between risk and coverage can be zero or negative in equilibrium, a phenomenon frequently observed in empirical studies.

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    File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.44632.de/dp614.pdf
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    Bibliographic Info

    Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 614.

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    Length: 34 p.
    Date of creation: 2006
    Date of revision:
    Handle: RePEc:diw:diwwpp:dp614

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    Keywords: Insurance markets; adverse selection; precautionary labor;

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    References

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    1. Netzer, Nick & Scheuer, Florian, 2007. "Taxation, insurance, and precautionary labor," Journal of Public Economics, Elsevier, vol. 91(7-8), pages 1519-1531, August.
    2. De Donder, Philippe & Hindriks, Jean J.G., 2006. "Does Propitious Selection Explain Why Riskier People Buy Less Insurance?," CEPR Discussion Papers 5640, C.E.P.R. Discussion Papers.
    3. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
    4. Jullien, Bruno & Salanié, Bernard & Salanié, François, 2001. "Screening Risk-Averse Agents Under Moral Hazard," IDEI Working Papers 131, Institut d'Économie Industrielle (IDEI), Toulouse.
    5. Pierre-André Chiappori & Bernard Salanié, 1997. "Testing for Asymmetric Information in Insurance Markets," Working Papers 97-11, Centre de Recherche en Economie et Statistique.
    6. de Meza, David & Webb, David C, 2001. "Advantageous Selection in Insurance Markets," RAND Journal of Economics, The RAND Corporation, vol. 32(2), pages 249-62, Summer.
    7. Eaton, Jonathan & Rosen, Harvey S., 1980. "Labor supply, uncertainty, and efficient taxation," Journal of Public Economics, Elsevier, vol. 14(3), pages 365-374, December.
    8. Simon C. Parker & Yacine Belghitar & Tim Barmby, 2005. "Wage Uncertainty and the Labour Supply of Self-Employed Workers," Economic Journal, Royal Economic Society, vol. 115(502), pages C190-C207, 03.
    9. Chassagnon, A. & Chiappori, P.A., 1994. "Insurance Under Moral Hazard and Adverse Selection: The Case of Pure Competition," Papers 28, Laval - Laboratoire Econometrie.
    10. Pierre‐André Chiappori & Bruno Jullien & Bernard Salanié & François Salanié, 2006. "Asymmetric information in insurance: general testable implications," RAND Journal of Economics, RAND Corporation, vol. 37(4), pages 783-798, December.
    11. Hartwick, John M., 2000. "Labor supply under wage uncertainty," Economics Letters, Elsevier, vol. 68(3), pages 319-325, September.
    12. John Cawley & Tomas Philipson, 1996. "An Empirical Examination of Information Barriers to Trade in Insurance," NBER Working Papers 5669, National Bureau of Economic Research, Inc.
    13. Amy Finkelstein & Kathleen McGarry, 2006. "Multiple Dimensions of Private Information: Evidence from the Long-Term Care Insurance Market," American Economic Review, American Economic Association, vol. 96(4), pages 938-958, September.
    14. Amy Finkelstein & James Poterba, 2004. "Adverse Selection in Insurance Markets: Policyholder Evidence from the U.K. Annuity Market," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 183-208, February.
    15. Hamish Low, 2005. "Self-Insurance in a Life-Cycle Model of Labor Supply and Savings," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(4), pages 945-975, October.
    16. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
    17. Cardon, James H & Hendel, Igal, 2001. "Asymmetric Information in Health Insurance: Evidence from the National Medical Expenditure Survey," RAND Journal of Economics, The RAND Corporation, vol. 32(3), pages 408-27, Autumn.
    18. Hemenway, David, 1990. "Propitious Selection," The Quarterly Journal of Economics, MIT Press, vol. 105(4), pages 1063-69, November.
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