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Adverse Selection, Aggregate Uncertainty, and the Role for Mutual Insurance Contracts


  • Smith, Bruce D
  • Stutzer, Michael J


A model of insurance markets analogous to that of Rothschild and Stiglitz (1976) is considered, with the additional feature that risk-neutral insurers face aggregate (undiversifiable) risk. In the presence of adverse selection and aggregate uncertainty and under a simple nondegeneracy condition on loss probabilities, the authors show that any equilibrium has the feature that some agents purchase participating policies (from mutual insurers) while others purchase nonparticipating policies (and, hence, do not share risk with their insurer). Specifically, agents with low loss probabilities signal their type by sharing aggregate risks with their insurer. Some empirical support for this prediction is provided. Copyright 1990 by the University of Chicago.

Suggested Citation

  • Smith, Bruce D & Stutzer, Michael J, 1990. "Adverse Selection, Aggregate Uncertainty, and the Role for Mutual Insurance Contracts," The Journal of Business, University of Chicago Press, vol. 63(4), pages 493-510, October.
  • Handle: RePEc:ucp:jnlbus:v:63:y:1990:i:4:p:493-510

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    References listed on IDEAS

    1. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-987, December.
    2. Nelson, Charles R & Startz, Richard, 1990. "Some Further Results on the Exact Small Sample Properties of the Instrumental Variable Estimator," Econometrica, Econometric Society, vol. 58(4), pages 967-976, July.
    3. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-1286, September.
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    Cited by:

    1. Pierre Picard, 2014. "Participating Insurance Contracts and the Rothschild-Stiglitz Equilibrium Puzzle," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 39(2), pages 153-175, September.
    2. Francesca Barigozzi & Renaud Bourlès & Dominique Henriet & Giuseppe Pignataro, 2017. "Pool size and the sustainability of optimal risk-sharing agreements," Theory and Decision, Springer, vol. 82(2), pages 273-303, February.
    3. Seog S. Hun, 2006. "Limited Competition, Information Asymmetry, and Organizational Forms," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 1(2), pages 1-14, February.
    4. Louis Lévy-Garboua & Claude Montmarquette & Jonathan Vaksmann & Marie Claire Villeval, 2017. "Voluntary Contributions to a Mutual Insurance Pool," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 19(1), pages 198-218, February.
    5. Michael K. McShane & Larry A. Cox, 2009. "Issuance Decisions and Strategic Focus: The Case of Long-Term Care Insurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 76(1), pages 87-108.
    6. Neil A. Doherty & Harris Schlesinger, 1992. "Insurance Markets with Noisy Loss Distributions," CESifo Working Paper Series 22, CESifo Group Munich.
    7. Dana A. Kerr, 2005. "The Effect of Ownership Structure on Insurance Company Litigation Strategy," The Journal of Legal Studies, University of Chicago Press, vol. 34(1), pages 273-294, January.
    8. Laux, Christian & Muermann, Alexander, 2006. "Mutual versus stock insurers: Fair premium, capital, and solvency," CFS Working Paper Series 2006/26, Center for Financial Studies (CFS).
    9. Magnus Lindmark & Lars-Fredrik Andersson & Mike Adams, 2006. "The Evolution and Development of the Swedish Insurance Market," Accounting History Review, Taylor & Francis Journals, vol. 16(3), pages 341-370.
    10. Braun, Alexander & Schmeiser, Hato & Rymaszewski, Przemysław, 2015. "Stock vs. mutual insurers: Who should and who does charge more?," European Journal of Operational Research, Elsevier, vol. 242(3), pages 875-889.
    11. Eling, Martin & Jia, Ruo & Yao, Yi, 2014. "Between-Group Adverse Selection: Evidence from Group Critical Illness Insurance," Working Papers on Finance 1403, University of St. Gallen, School of Finance, revised Oct 2014.
    12. Renaud Bourlès, 2006. "How Can Insurance Companies Compete With MutualInsurers? The Role of Commitment," Working Papers halshs-00410765, HAL.
    13. Eric Stephens & James R. Thompson, 2015. "Separation Without Exclusion in Financial Insurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 82(4), pages 853-864, December.
    14. Laux, Christian & Muermann, Alexander, 2010. "Financing risk transfer under governance problems: Mutual versus stock insurers," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 333-354, July.
    15. Georges Dionne & Nathalie Fombaron & Neil Doherty, 2012. "Adverse Selection in Insurance Contracting," Cahiers de recherche 1231, CIRPEE.

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