| Abstract: |
In this survey we present some of the more significant results in the
literature on adverse selection in insurance markets. Sections 1 and 2
introduce the subject, and Section 3 discusses the monopoly model developed by
Stiglitz (1977) for the case of single-period contracts, which has been
extended by many authors to the multi-period case. The introduction of
multi-period contracts raises issues that are discussed in detail; time
horizon, discounting, commitment of the parties, contract renegotiation, and
accident underreporting. Section 4 covers the literature on competitive
contracts, where the analysis is more complicated because insurance companies
must take competitive pressures into account when they set incentive
contracts. As pointed out by Rothschild and Stiglitz (1976), there is not
necessarily a Nash equilibrium when there is adverse selection. However,
market equilibrium can be sustained when principals anticipate competitive
reactions to their behavior. Multi-period contracting is discussed. We show
that different predictions on the evolution of insurer profits over time can
be obtained from different assumptions concerning the sharing of information
between insurers about an individual's choice of contracts and accident
experience. The roles of commitment and renegotiation between the parties to
the contract are important. Section 5 introduces models that consider moral
hazard and adverse selection simultaneously, and Section 6 covers adverse
selection when people can choose their risk status. Section 7 discusses many
extensions to the basic models such as risk categorization, multidimensional
adverse selection, symmetric imperfect information, double-sided adverse
selection, participating contracts, and nonexclusive contracting. |