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Is There Propitious Selection in Insurance Markets?

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  • Tsvetanka Karagoyozova

    (University of Connecticut)

  • Peter Siegelman

    (University of Connecticut)

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 the 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 propitious selection alone can not 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 Karagoyozova & Peter Siegelman, 2006. "Is There Propitious Selection in Insurance Markets?," Working papers 2006-20, University of Connecticut, Department of Economics.
  • Handle: RePEc:uct:uconnp:2006-20 Note: We thank seminar participants at the University of Connecticut,Wesleyan University and UC Berkeley Law School for useful comments. We would also like to thank Tom Baker, Set Chandler, Dhammika Dharmapala, Kathleen Segerson, Dan Silverman, Christian Zimmermann and especially Jill Horwitz for comments and encouragement. Any remaining conceptual or other errors are our fault. Part of this work was completed while Siegelman was visiting at the University of Michigan Law School (Spring 2006).
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    References listed on IDEAS

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    Cited by:

    1. Arvidsson, Sara, 2010. "Reducing asymmetric information with usage-based automobile insurance," Working Papers 2010:2, Swedish National Road & Transport Research Institute (VTI), revised 03 Feb 2011.
    2. Buchmueller, Thomas C. & Fiebig, Denzil G. & Jones, Glenn & Savage, Elizabeth, 2013. "Preference heterogeneity and selection in private health insurance: The case of Australia," Journal of Health Economics, Elsevier, vol. 32(5), pages 757-767.

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