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Deductible or Co-Insurance: Which is the Better Insurance Contract under Adverse Selection?

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  • Michael Breuer

    () (Socioeconomic Institute, University of Zurich)

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    Abstract

    The standard solution to adverse selection is the separating equilibrium introduced by Rothschild and Stiglitz. Usually, the Rothschild-Stiglitz argument is developed in a model that allows for two states of the world only. In this paper adverse selection is dis-cussed for continuous loss distributions. This gives rise to the new problem of finding the proper form of an insurance contract to impose partial insurance of the low risks. This paper contributes to the discussion on optimal insurance. It analyzes two basic forms of insurance contracts: A contract with a deductible and a contract imposing a positive co-insurance rate. Since high risks can always self-reveal themselves as high risks and buy the optimal insurance contract at high risks’ premiums the Pareto-superior insurance contract is the one that leaves the low risks with higher expected utility while deterring high risks from joining the contract that is designed for low risks. The deductible contract turns out to be superior if premiums contain a sufficiently high loading.

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    File URL: http://www.soi.uzh.ch/research/wp/2004/wp0401.pdf
    File Function: Revised version, 2004
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    Bibliographic Info

    Paper provided by University of Zurich, Socioeconomic Institute in its series Working Papers with number 0401.

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    Length: 19 pages
    Date of creation: Jan 2004
    Date of revision: Oct 2004
    Handle: RePEc:soz:wpaper:0401

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    Related research

    Keywords: Insurance; Adverse Selection; Deductible; Co-Insurance;

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    1. Andreas Polk & Armin Schmutzler, 2003. "Lobbying against Environmental Regulation vs. Lobbying for Loopholes," Working Papers 0301, University of Zurich, Socioeconomic Institute.
    2. Zava Aydemir & Stefan Buehler, 2002. "Estimating Vertical Foreclosure in U.S. Gasoline Supply," Working Papers 0212, University of Zurich, Socioeconomic Institute.
    3. Yves Schneider & Peter Zweifel, 2004. "How Much Internalization of Nuclear Risk Through Liability Insurance?," Journal of Risk and Uncertainty, Springer, vol. 29(3), pages 219-240, December.
    4. Stefan Buehler & Armin Schmutzler & Men-Andri Benz, 2002. "Infrastructure Quality in Deregulated Industries: Is there an Underinvestment Problem?," Working Papers 0209, University of Zurich, Socioeconomic Institute.
    5. Daniel Halbheer & Sarah Niggli & Armin Schmutzler, 2003. "What does it take to sell Environmental Policy? An empirical Analysis of Referendum Data," Working Papers 0304, University of Zurich, Socioeconomic Institute, revised Apr 2005.
    6. Andreas Polk, 2002. "Multilateral Agreement On Investments (MAI) - A Critical Assessment From an Industrial Economics Point of View," Working Papers 0201, University of Zurich, Socioeconomic Institute, revised Feb 2002.
    7. Borek, Thomas & Bühler, Stefan & Schmutzler, Armin, 2003. "Weddings with Uncertain Prospects - Mergers under Asymmetric Information," CEPR Discussion Papers 3839, C.E.P.R. Discussion Papers.
    8. Rainer Winkelmann, 2002. "Subjektive Daten in der empirischen Wirtschaftsforschung: Probleme und Perspektiven," Working Papers 0207, University of Zurich, Socioeconomic Institute, revised Jul 2002.
    9. Bühler, Stefan & Schmutzler, Armin, 2003. "Who Integrates?," CEPR Discussion Papers 4066, C.E.P.R. Discussion Papers.
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