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Harmful competition in the insurance markets

  • Giuseppe De Feo

    ()

    (Department of Economics, University of Strathclyde)

  • Jean Hindriks

    ()

    (Department of Economics and CORE, Universite catholique de Louvain, Belgium)

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 and that adverse selection is in general worse under competition than under monopoly. The reason is that monopoly can exploit its market power to relax incentive constraints by cross-subsidization between different risk types. Cream-skimming behavior, on the contrary, prevents competitive firms from using implicit transfers. In effect monopoly is shown to provide better coverage to those buying insurance but at the cost of limiting participation to insurance. 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. However, most of the surplus is retained by the firm and, as a result, most individuals prefer competitive markets notwithstanding their performance is generally poorer than monopoly.

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File URL: http://www.strath.ac.uk/media/departments/economics/researchdiscussionpapers/2009/09-21.pdf
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Paper provided by University of Strathclyde Business School, Department of Economics in its series Working Papers with number 0921.

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Length: 19 pages
Date of creation: Oct 2009
Date of revision:
Handle: RePEc:str:wpaper:0921
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  1. Engers, Maxim & Fernandez, Luis F, 1987. "Market Equilibrium with Hidden Knowledge and Self-selection," Econometrica, Econometric Society, vol. 55(2), pages 425-39, March.
  2. HINDRIKS, Jean & DE DONDER, Philippe, 2001. "The politics of redistributive social insurance," CORE Discussion Papers 2001054, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  3. Alberto Bisin & Piero Gottardi, 2006. "Efficient Competitive Equilibria with Adverse Selection," Journal of Political Economy, University of Chicago Press, vol. 114(3), pages 485-516, June.
  4. 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).
  5. Jaffee, Dwight & Stiglitz, Joseph, 1990. "Credit rationing," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 16, pages 837-888 Elsevier.
  6. Hellwig, Martin, 1987. "Some recent developments in the theory of competition in markets with adverse selection ," European Economic Review, Elsevier, vol. 31(1-2), pages 319-325.
  7. Mailath, George J, 1987. "Incentive Compatibility in Signaling Games with a Continuum of Types," Econometrica, Econometric Society, vol. 55(6), pages 1349-65, November.
  8. P. Dubey & J. Geanakoplos, 2001. "Competitive Pooling: Rothschild-Stiglitz Reconsidered," Department of Economics Working Papers 01-10, Stony Brook University, Department of Economics.
  9. John G. Riley, 2001. "Silver Signals: Twenty-Five Years of Screening and Signaling," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 432-478, June.
  10. 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.
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