Does Adverse Selection Matter? Evidence from a Natural Experiment
AbstractThe empirical evidence of adverse selection in insurance markets is mixed. The problem in assessing the extent of adverse selection is that private information, on which agents act, is generally unobservable to the researcher, which makes it difficult to distinguish between adverse selection and moral hazard. Unique micro data, from a dental insurance natural experiment, is here used to provide a direct test of selection. All agents in a population were stratified into different risk classes, and were unexpectedly given the opportunity to insure their dental care costs. The setup of the insurance makes it possible to observe a proxy for private information. Interestingly, results differ across risk classes. Within high-risk classes, there is evidence of adverse selection and within low-risk classes, the results, surprisingly, indicate an advantageous selection. This dual selection can explain the limited empirical evidence for adverse selection in insurance markets in the literature: the two effects may balance out on the aggregate level. The paper also presents a model of insurance choice that can harbor both adverse and advantageous selection. The pattern in the data is explained by differences in the effectiveness of prevention across high and low risk classes.
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Bibliographic InfoPaper provided by Stockholm School of Economics in its series Working Paper Series in Economics and Finance with number 575.
Length: 38 pages
Date of creation: 10 Nov 2004
Date of revision:
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Asymmetric information; Adverse Selection; Advantageous Selection; Health Insurance;
Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
- I11 - Health, Education, and Welfare - - Health - - - Analysis of Health Care Markets
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