, Volume 44, Issue 2, pp 187-211
Date: 27 Jun 2009

Competitive screening in insurance markets with endogenous wealth heterogeneity

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Abstract

We examine equilibria in competitive insurance markets with adverse selection when wealth differences arise endogenously from unobservable savings or labor supply decisions. The endogeneity of wealth implies that high-risk individuals may ceteris paribus exhibit the lower marginal willingness to pay for insurance than low risks, a phenomenon that we refer to as irregular-crossing preferences. In our model, both risk and patience (or productivity) are privately observable. In contrast to the models in the existing literature, where wealth heterogeneity is exogenously assumed, equilibria in our model no longer exhibit a monotone relation between risk and coverage. Individuals who purchase larger coverage are no longer higher risks, a phenomenon frequently observed in empirical studies.

We are grateful to Daron Acemoglu, Abhijit Banerjee, Felix Bierbrauer, Friedrich Breyer, Wolfgang Buchholz, Peter Diamond, Glenn Ellison, Oliver Fabel, Amy Finkelstein, Jon Gruber, Mathias Kifmann, Jim Poterba, Casey Rothschild, Harris Schlesinger, Arthur Snow, two anonymous referees and seminar participants at the Universities of Augsburg, Konstanz, MIT, Zurich and the 2007 Annual Meetings of the Risk Theory Society, the American Risk and Insurance Association, and the European Economic Association for valuable comments on earlier versions of this paper. The usual disclaimer applies.