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Can Propitious Selection Stabilize Insurance markets?

Author

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  • Tsvetanka Karagyozova
  • Peter Siegelman

Abstract

The theory of adverse selection in insurance markets has been enormously influential among scholars, regulators, and the judiciary. But empirical support for adverse selection has been much less persuasive, and several recent studies have found little or no evidence of such selection in insurance markets. "Propitious" (advantageous) selection offers an alternative mechanism that is consistent with these empirical findings. Like adverse selection, the theory assumes that insureds have an informational advantage over insurers. However, propitious selection relies on a plausible assumption that risk aversion is negatively correlated with the riskiness, or probability, of loss across insureds - the more risk-averse are also the more careful, and hence are least likely to experience a loss. Theorists have recognized the possibility of equilibria in which highly risk averse insureds with a low probability of loss are willing to remain in the market, despite an actuarially unfair premium. But these conclusions derive from models with only two types of insureds. We use a simulation model that allows for flexible correlation between risk aversion and riskiness across a continuum of types, with plausible distributions of risk aversion and riskiness. We find that (exogenous) negative correlation between risk and risk aversion alone cannot preserve equilibrium in insurance markets. When insureds have moderate uncertainty about their own riskiness, however, equilibrium does become possible, albeit with considerable selection.

Suggested Citation

  • Tsvetanka Karagyozova & Peter Siegelman, 2012. "Can Propitious Selection Stabilize Insurance markets?," Journal of Insurance Issues, Western Risk and Insurance Association, vol. 35(2), pages 121-158.
  • Handle: RePEc:wri:journl:v:35:y:2012:i:2:p:121-158
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    Cited by:

    1. De Donder, Philippe & Pestieau, Pierre, 2013. "Private, social and self-insurance for long-term care in the presence of family help: A political economy analysis," CEPR Discussion Papers 9587, C.E.P.R. Discussion Papers.
    2. De Donder, Philippe & Peluso, Eugenio, 2014. "Politically Sustainable Probabilistic Minority Targeting," TSE Working Papers 14-509, Toulouse School of Economics (TSE).
    3. DE DONDER, Philippe & PESTIEAU, Pierre, 2011. "Private, social and self insurance for long-term care: A political economy analysis," CORE Discussion Papers 2011053, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    4. repec:spr:sochwe:v:49:y:2017:i:3:d:10.1007_s00355-016-0999-3 is not listed on IDEAS
    5. De Donder, Philippe & Leroux, Marie-Louise, 2015. "The political choice of social long term care transfers when family gives time and money," TSE Working Papers 15-569, Toulouse School of Economics (TSE), revised 26 May 2015.
    6. Philippe De Donder & Marie-Louise Leroux, 2015. "The Political Economy of (in)formal Long Term Care Transfers," Cahiers de recherche 1508, Chaire de recherche Industrielle Alliance sur les enjeux économiques des changements démographiques.

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