Efficiency of competition in insurance markets with adverse selection

G. De Feo, J. Hindriks

Research output: Working paperDiscussion paper

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.
LanguageEnglish
Place of PublicationLouvain-la-Neuve, Belgium
Number of pages32
Publication statusPublished - Jul 2005

Fingerprint

Monopoly
Adverse selection
Insurance market
Traders
Market power
Insurance
Dual theory
Simulation
Incentives
Gains from trade
Monopolist

Keywords

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

Cite this

De Feo, G., & Hindriks, J. (2005). Efficiency of competition in insurance markets with adverse selection. Louvain-la-Neuve, Belgium.
De Feo, G. ; Hindriks, J. / Efficiency of competition in insurance markets with adverse selection. Louvain-la-Neuve, Belgium, 2005.
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De Feo, G & Hindriks, J 2005 'Efficiency of competition in insurance markets with adverse selection' Louvain-la-Neuve, Belgium.

Efficiency of competition in insurance markets with adverse selection. / De Feo, G.; Hindriks, J.

Louvain-la-Neuve, Belgium, 2005.

Research output: Working paperDiscussion paper

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AB - 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.

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De Feo G, Hindriks J. Efficiency of competition in insurance markets with adverse selection. Louvain-la-Neuve, Belgium. 2005 Jul.