Harmful competition in insurance markets

Giuseppe De Feo, Jean Hindriks

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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 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.
Original languageEnglish
Pages (from-to)213-226
Number of pages14
JournalJournal of Economic Behaviour and Organization
Volume106
Early online date2 Jul 2014
DOIs
Publication statusPublished - 31 Oct 2014

Keywords

  • monopoly
  • competition
  • insurance
  • adverse selection

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