Multi-Period Insurance Contracts

Abstract

This paper examines the form of insurance contracts in the presence of asymmetric information about consumers’ accident probabilities. Our goal is to understand the adjustment in contract terms as a function of accident histories in a finite horizon model. We also compare these adjustments between alternative market structures. Our principal findings indicate that history dependent insurance contracts serve a useful sorting role. Individuals who declare themselves ‘low risks’ to insurance companies face adverse contracturai terms if they subsequently have many accidents. These adjustments are strongest in the case of a single insurance seller but are present in the competitive model as well.

We wish to thank Costas Azariadis, John Bigelow, Marcel Boyer, V.V. Chart, George Dionne, Larry Jones, P. Lasserre, Paul Milgrom, Joseph Stiglitz, Colette Waternaux-and seminar participants at the University of Chicago, Northwestern University, the University of Montreal, participants at the 1984 Summer Econometric Society meetings and the anonymous referees for comments.