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Testing for Asymmetric Information Using 'Unused Observables' in Insurance Markets: Evidence from the U.K. Annuity Market

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  • Amy Finkelstein
  • James Poterba

Abstract

This paper tests for asymmetric information in the U.K. annuity market of the 1990s by trying to identify 'unused observables,' attributes of individual insurance buyers that are correlated both with subsequent claims experience and with insurance demand but that insurance companies did not use to set insurance prices. Unlike the widely-used positive correlation test for asymmetric information, which searches for a positive correlation between insurance demand and risk experience, the unused observables test is not confounded by heterogeneity in individual preference parameters that may affect insurance demand. We identify residential location as an unused observable in the U.K. annuity market of this period, and show that this variable was correlated both with annuity demand and with prospective mortality. Thus even though residential location was observed by all market participants, the decision not to condition prices on it created the same types of market inefficiencies that arise when annuity buyers have private information about mortality risk. Our findings raise interesting questions about how insurance companies select the set of buyer attributes that they use in setting policy prices. In the decade following the period that we study, U.K. insurance companies changed their pricing practices and began to condition annuity prices on a buyer's postcode.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12112.

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Date of creation: Mar 2006
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Handle: RePEc:nbr:nberwo:12112

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  1. 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.
  2. David M. Cutler & Angus S. Deaton & Adriana Lleras-Muney, 2006. "The Determinants of Mortality," NBER Working Papers 11963, National Bureau of Economic Research, Inc.
  3. Pierre-André Chiappori & Bruno Jullien & Bernard Salanié & François Salanié, 2002. "Asymmetric Information in Insurance : General Testable Implications," Working Papers 2002-42, Centre de Recherche en Economie et Statistique.
  4. Dean Karlan & Jonathan Zinman, 2009. "Observing Unobservables: Identifying Information Asymmetries With a Consumer Credit Field Experiment," Econometrica, Econometric Society, Econometric Society, vol. 77(6), pages 1993-2008, November.
  5. Hemenway, David, 1990. "Propitious Selection," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 105(4), pages 1063-69, November.
  6. Alma Cohen, 2005. "Asymmetric Information and Learning: Evidence from the Automobile Insurance Market," The Review of Economics and Statistics, MIT Press, vol. 87(2), pages 197-207, May.
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  8. Alma Cohen & Liran Einav, 2005. "Estimating Risk Preferences from Deductible Choice," NBER Working Papers 11461, National Bureau of Economic Research, Inc.
  9. David McCarthy & Olivia S. Mitchell, 2003. "International Adverse Selection in Life Insurance and Annuities," NBER Working Papers 9975, National Bureau of Economic Research, Inc.
  10. Jeffrey R. Brown & Amy Finkelstein, 2004. "Supply or Demand: Why is the Market for Long-Term Care Insurance So Small?," NBER Working Papers 10782, National Bureau of Economic Research, Inc.
  11. Hanming Fang & Michael P. Keane & Dan Silverman, 2006. "Sources of Advantageous Selection: Evidence from the Medigap Insurance Market," NBER Working Papers 12289, National Bureau of Economic Research, Inc.
  12. Jaap H. Abbring & Pierre-Andre Chiappori, 2004. "Moral Hazard and Dynamic Insurance Data," 2004 Meeting Papers 316, Society for Economic Dynamics.
  13. repec:rje:randje:v:37:y:2006:i:4:p:783-798 is not listed on IDEAS
  14. Amy Finkelstein & James Poterba, 2000. "Adverse Selection in Insurance Markets: Policyholder Evidence from the U.K. Annuity Market," NBER Working Papers 8045, National Bureau of Economic Research, Inc.
  15. Pierre-André Chiappori & Bernard Salanié, 1997. "Testing for Asymmetric Information in Insurance Markets," Working Papers 97-11, Centre de Recherche en Economie et Statistique.
  16. James P. Smith, 1999. "Healthy Bodies and Thick Wallets: The Dual Relation between Health and Economic Status," Journal of Economic Perspectives, American Economic Association, vol. 13(2), pages 145-166, Spring.
  17. Georges Dionne & Christian Gourieroux & Charles Vanasse, 2001. "Testing for Evidence of Adverse Selection in the Automobile Insurance Market: A Comment," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 109(2), pages 444-473, April.
  18. Tomas J. Philipson & Gary S. Becker, 1998. "Old-Age Longevity and Mortality-Contingent Claims," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 106(3), pages 551-573, June.
  19. Han, Aaron & Hausman, Jerry A, 1990. "Flexible Parametric Estimation of Duration and Competing Risk Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 5(1), pages 1-28, January-M.
  20. 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.
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