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Empirical analyses of selection and welfare in insurance markets: a self-indulgent survey

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Abstract

This review article surveys work that has been done using an empirical framework for analyzing selection in insurance markets developed by Einav et al. (Einav et al., Quarterly Journal of Economics 125:877–921, 2010a). We briefly review that framework, and then describe a number of empirical applications that researchers have undertaken across an array of settings in both insurance and credit markets. We also discuss some of the useful extensions to the original framework that others have made and applied. The review is intended to be useful for scholars who may want to apply the framework in their own work on insurance, credit, or other selection markets.

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Notes

  1. Well, almost no one. Amy’s husband was sure it was in the textbook of Mas-Colell et al. (1995) but, per usual, she ignored him. Several years later when Whinston became her colleague, he also commented that the algebra behind the graph can be found on page 441. Like we said, we knew the idea wasn’t new.

  2. No relation to the Editor.

  3. This stylized example assumes that individuals differ only in their (privately known) expected costs. As shown by Fang and Wu (2018), in a more general setting in which individuals also differ in their utility functions—for example how risk-averse they are—it is possible that insurance markets exhibit advantageous selection, in which the marginal cost curve is upward sloping over some portion of the demand curve. This could be the case, for example, when demand for insurance is primarily driven by heterogeneous risk aversion, and the most risk-averse consumers are also the ones with the lowest expected claims. Some empirical examples include the market for private health insurance to supplement the public Medicare insurance in the US (Fang et al. 2008) and the US market for long-term care insurance (Finkelstein and McGarry 2006). Indeed, insurance brokers quip that long-term care insurance is purchased by the “healthy, wealthy, and anxious.”

  4. There are a number of ways to relax this, for example by allowing for administrative costs to the firm or moral hazard effects of insurance, either of which could produce a demand curve that crosses the marginal cost curve and an efficient equilibrium in which only some fraction of individuals (those with willingness to pay above their cost) should be insured.

  5. This situation is not common in their application, and rarely arises. When it does, they propose to use a Riley equilibrium (Riley 1979) instead, which ensures existence in their context.

  6. Casey Rothschild made a closely related point in his discussion of Einav’s “Geneva Lecture” in the EGRIE annual meeting in Vienna, 2022. If individuals only vary in their realized risk, and welfare is assessed from behind the veil of ignorance, high-risk types are worse off from an “ex ante” perspective—i.e., they have lower expected consumption. They therefore would have greater welfare weights in any social welfare function. This could alter results regarding optimal public policies that attempt to combat adverse selection. For example, it would lead to a higher optimal uniform subsidy relative to the baseline EF framework. See also Fleurbaey (2018) for a more extensive discussion of this topic.

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Author information

Authors and Affiliations

  1. Stanford University, Stanford, CA, USA

    Liran Einav

  2. MIT, Cambridge, MA, USA

    Amy Finkelstein

  3. NBER, Cambridge, MA, USA

    Liran Einav & Amy Finkelstein

Authors
  1. Liran Einav
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  2. Amy Finkelstein
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Corresponding author

Correspondence to Liran Einav.

Additional information

This article was invited by and prepared for the Geneva Risk and Insurance Review. It follows up Einav’s Geneva Risk Economics Lecture at the annual meeting of the European Group of Risk and Insurance Economists (EGRIE) in Vienna, September 2022. We are very grateful to Casey Rothschild for encouraging us to write this review, as well as for helpful discussion and constructive comments, to Alex Muermann and an anonymous reviewer for helpful suggestions, and to Miray Omurtak for superb research assistance.

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Einav, L., Finkelstein, A. Empirical analyses of selection and welfare in insurance markets: a self-indulgent survey. Geneva Risk Insur Rev 48, 167–191 (2023). https://doi.org/10.1057/s10713-023-00084-3

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