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Participating insurance contracts and the Rothschild-Stiglitz equilibrium puzzle

  • Pierre Picard

    (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X)

We show that an equilibrium always exists in the Rothschild-Stiglitz insurance market model with adverse selection when insurers can offer either non- participating or participating policies, i.e. insurance contracts which may involve policy dividends or supplementary calls for premium. The equilibrium coincides with the Miyazaki- Spence-Wilson equilibrium, which may involves cross-subsidization between contracts within subgroups of individuals. The paper establishes that participating policies act as an implicit threat that dissuades deviant insurers who aim at attracting low risk individuals only. The model predicts that the mutual corporate form should be prevalent in insurance markets or submarkets where second-best Pareto efficiency requires cross-subsidization between risk types. Stock insurers and mutuals may coexist, with stock insurers offering insurance coverage at actuarial price and mutuals cross-subsidizing risks.

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Paper provided by HAL in its series Working Papers with number hal-00413825.

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Date of creation: 07 Sep 2009
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Handle: RePEc:hal:wpaper:hal-00413825
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  1. 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.
  2. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
  3. John H. Boyd & Edward C. Prescott & Bruce D. Smith, 1988. "Organizations in Economic Analysis," Canadian Journal of Economics, Canadian Economics Association, vol. 21(3), pages 477-91, August.
  4. Crocker, Keith J. & Snow, Arthur, 1985. "The efficiency of competitive equilibria in insurance markets with asymmetric information," Journal of Public Economics, Elsevier, vol. 26(2), pages 207-219, March.
  5. Hellwig,Martin, 1986. "Some recent developments in the theory of competition in markets with adverse selection," Discussion Paper Serie A 82, University of Bonn, Germany.
  6. Riley, John G, 1979. "Informational Equilibrium," Econometrica, Econometric Society, vol. 47(2), pages 331-59, March.
  7. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  8. Spence, Michael, 1978. "Product differentiation and performance in insurance markets," Journal of Public Economics, Elsevier, vol. 10(3), pages 427-447, December.
  9. Smith, Bruce D & Stutzer, Michael, 1995. "A Theory of Mutual Formation and Moral Hazard with Evidence from the History of the Insurance Industry," Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 545-77.
  10. James A. Ligon & Paul D. Thistle, 2005. "The Formation of Mutual Insurers in Markets with Adverse Selection," The Journal of Business, University of Chicago Press, vol. 78(2), pages 529-556, March.
  11. Doherty, N.A. & Dionne, G., 1987. "Insurance with Undiversifiable Risk," Cahiers de recherche 8710, Universite de Montreal, Departement de sciences economiques.
  12. Engers, Maxim & Fernandez, Luis F, 1987. "Market Equilibrium with Hidden Knowledge and Self-selection," Econometrica, Econometric Society, vol. 55(2), pages 425-39, March.
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