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Equilibrium in Competitive Insurance Markets with Moral Hazard

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  • Richard Arnott
  • Joseph Stiglitz

Abstract

This paper examines the existence and nature of competitive equilibrium with moral hazard. The more insurance an individual has, the less care will he take. Consequently, insurance firms attempt to restrict their clients' aggregate insurance purchases. If individuals' aggregate insurance purchases are observable, each firm will ration the amount of insurance its clients can purchase and insist that they purchase no insurance from other firms. This paper focuses on the alternative situation where firms cannot observe their clients' aggregate insurance purchases. We show that firms will still attempt to restrict their clients' aggregate purchases, but now they must do so indirectly. One possibility is that all firms sell only policies with a sufficiently large amount of coverage that individuals choose to purchase insurance from only one firm. Another possibility is that each firm offers a latent policy in addition to its regular policy. Latent policies are not purchased in equilibrium, but serve to restrict entry. If an entering firm offers a supplementary policy, an individual will purchase not only this policy plus his previous policy but also the latent policy. The latent policy is designed so that the individual reduces effort by enough to render any entering policy unprofitable.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3588.

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Date of creation: Jan 1991
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Handle: RePEc:nbr:nberwo:3588

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  1. Joseph E. Stiglitz & Andrew Weiss, 1987. "Macro-Economic Equilibrium and Credit Rationing," NBER Working Papers 2164, National Bureau of Economic Research, Inc.
  2. Hellwig,Martin, 1986. "Some recent developments in the theory of competition in markets with adverse selection," Discussion Paper Serie A, University of Bonn, Germany 82, University of Bonn, Germany.
  3. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  4. 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, MIT Press, vol. 90(4), pages 630-49, November.
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