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Efficiency of competition in insurance markets with adverse selection

Author

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  • DE FEO, Giuseppe
  • HINDRIKS, Jean

Abstract

There is a general presumption that competition is a good thing. In this paper we show that competition in the insurance markets can be bad when there is adverse selection. Using the dual theory of choice under risk, we are able to fully characterize both the competitive and the monopoly market outcomes. When there are two types of risk, the monopoly dominates competition if and only if competition leads to market unravelling. When there are a continuum of types the efficiency of competition is less trivial. In effect monopoly is shown to provide better insurance but at the cost of driving out some agents from the market. Performing simulation for different distributions of risk, we find that monopoly in general performs (much) better than competition in terms of the realization of the gains from trade across all traders in equilibrium. The reason is that the monopolist can exploit its market power to relax the incentive constraints.

Suggested Citation

  • DE FEO, Giuseppe & HINDRIKS, Jean, 2005. "Efficiency of competition in insurance markets with adverse selection," CORE Discussion Papers 2005054, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  • Handle: RePEc:cor:louvco:2005054
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    File URL: https://uclouvain.be/en/research-institutes/immaq/core/dp-2005.html
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Giuseppe De Feo & Jean Hindriks, 2009. "Harmful competition in the insurance markets," Working Papers 0921, University of Strathclyde Business School, Department of Economics.
    2. Philippe Donder & Jean Hindriks, 2009. "Adverse selection, moral hazard and propitious selection," Journal of Risk and Uncertainty, Springer, vol. 38(1), pages 73-86, February.

    More about this item

    Keywords

    monopoly; competition; non-expected utility; insurance; adverse selection;

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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