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Dynamic Insurance Contracts and Adverse Selection
Author(s) -
Janssen Maarten C. W.,
Karamychev Vladimir A.
Publication year - 2005
Publication title -
journal of risk and insurance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.055
H-Index - 63
eISSN - 1539-6975
pISSN - 0022-4367
DOI - 10.1111/j.0022-4367.2005.00115.x
Subject(s) - adverse selection , rothschild , moral hazard , insurance policy , economics , incentive , yield (engineering) , microeconomics , actuarial science , welfare , business , materials science , archaeology , metallurgy , history , market economy
We take a dynamic perspective on insurance markets under adverse selection and study a dynamic version of the Rothschild and Stiglitz model. We investigate the nature of dynamic insurance contracts by considering both conditional and unconditional dynamic contracts. An unconditional dynamic contract has insurance companies offering contracts where the terms of the contract depend on time, but not on the occurrence of past accidents. Conditional dynamic contracts make the actual contract also depend on individual past performance (such as in car insurances). We show that dynamic insurance contracts yield a welfare improvement only if they are conditional on past performance. With conditional contracts, the first‐best can be approximated if the contract lasts long. Moreover, this is true for any fraction of low‐risk agents in the population.