Harmful competition in the insurance markets
AbstractThere is a general presumption that competition is a good thing. In this paper we show that competition in the insurance markets can be bad and that adverse selection is in general worse under competition than under monopoly. The reason is that monopoly can exploit its market power to relax incentive constraints by cross-subsidization between different risk types. Cream-skimming behavior, on the contrary, prevents competitive firms from using implicit transfers. In effect monopoly is shown to provide better coverage to those buying insurance but at the cost of limiting participation to insurance. Performing simulation for di erent distributions of risk, we find that monopoly in general performs (much) better than competition in terms of the realization of the gains from trade across all traders in equilibrium. However, most of the surplus is retained by the firm and, as a result, most individuals prefer competitive markets notwithstanding their performance is generally poorer than monopoly.
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Bibliographic InfoPaper provided by Scottish Institute for Research in Economics (SIRE) in its series SIRE Discussion Papers with number 2009-46.
Date of creation: 2009
Date of revision:
monopoly; competition; insurance; adverse selection;
Other versions of this item:
- G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
- H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
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