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An Empirical Examination of Information Barriers to Trade in Insurance

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  • John Cawley
  • Tomas Philipson

Abstract

This paper tests restrictions implied by the canonical theory of insurance under asymmetric information using ideal data that contains the self-perceived and actual mortality risk of individuals, as well as the price and quantity of their life insurance. We report several findings which are hard to reconcile with the canonical theory. First, we find a striking independence of self-perceived risk and the price of insurance. Second, we find strong evidence of the opposite type of non-linear pricing than predicted by theory: the theory predicts that prices rise with quantity, but we find that they fall. Third, we find that risk is negatively correlated with the quantity of insurance purchased although the theory predicts a positive correlation. Fourth, we find that a substantial fraction of individuals hold multiple insurance contracts, which casts doubt on the prediction that unit prices rise with quantity because multiple small contracts dominate a large one in such a case. Lastly, we test the accuracy of the self-perceived risk of the insured through estimating the induced profits they imply. We conclude by discussing the robustness of these results and the questions they raise for future theoretical models.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5669.

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Date of creation: Jul 1996
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Publication status: published as Cawley, John, and Tomas Philipson. An Empirical Examination of Information Barriers to Trade in Insurance." American Economic Review, September 1999, 89(4): 827-846.
Handle: RePEc:nbr:nberwo:5669

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  13. 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.
  14. Riley, John G, 1979. "Informational Equilibrium," Econometrica, Econometric Society, vol. 47(2), pages 331-59, March.
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  19. Daniel S. Hamermesh, 1982. "Expectations, Life Expectancy, and Economic Behavior," NBER Working Papers 0835, National Bureau of Economic Research, Inc.
  20. Mailath, George J, 1987. "Incentive Compatibility in Signaling Games with a Continuum of Types," Econometrica, Econometric Society, vol. 55(6), pages 1349-65, November.
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  24. Townsend, Robert M., 1988. "Information constrained insurance : The revelation principle extended," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 411-450.
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