Harmful competition in the insurance markets

Giuseppe 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 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.
Original languageEnglish
Publication statusPublished - 2009

Fingerprint

Monopoly
Insurance market
Insurance
Participation
Market power
Competitive market
Cream skimming
Incentives
Traders
Cross-subsidization
Surplus
Adverse selection
Gains from trade

Cite this

De Feo, G., & Hindriks, J. (2009). Harmful competition in the insurance markets.
De Feo, Giuseppe ; Hindriks, J. / Harmful competition in the insurance markets. 2009.
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De Feo, G & Hindriks, J 2009 'Harmful competition in the insurance markets'.

Harmful competition in the insurance markets. / De Feo, Giuseppe; Hindriks, J.

2009.

Research output: Working paperDiscussion paper

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T1 - Harmful competition in the insurance markets

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N2 - 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.

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 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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BT - Harmful competition in the insurance markets

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