Monday, March 27, 2006

Information asymmetries in insurance markets are good!

I'm not really qualified to comment on the relative position of this paper on the sense/nonsense line, but it has an odd intuitive plausibility that I don't understand at all.
The main contribution is to show that eliminating informational asymmetries by imposing information sharing is detrimental, a result that apparently contradicts previous contributions on the efficiency effects of categorical discrimination under asymmetric information (e.g., Crocker and Snow 1986). One facet of the present result is that allowing asymmetries of information to develop through time decreases the efficiency of competition ex post, thereby enlarging the set of viable long-term contracts in the ex ante competition game, thus increasing welfare. Another facet is insurees' enhanced commitment: in the case in which information is not transmitted to prospective insurers, individuals obtain a partial commitment power not to switch insurers ex post in case of good news. This credible commitment device allows them to extract a higher level of long-term insurance from ex ante competition, and notably insurance against the "risk" of having no accident and being reclassified as a good type. Thus allowing asymmetries of information to develop alleviates the problem of the provision of long-term insurance. This normative result puts forward a clear argument in favor of deregulation, even though (and even because) it would produce asymmetric information in insurance markets.

Furthermore, a secondary result of the analysis is that preventing the transmission (across insurers) of information about insurees' past contract choices—or, more realistically, making sure that insurers do not make ex post offers contingent on ex ante contract choice—results in a strict welfare improvement, through menus of contracts. This is true, although information about ex ante contract choices is worthless in this ex ante symmetric information situation. The fact that menus of contracts can strictly improve on single contracts in a symmetric information environment is a new result.

1 Comments:

Anonymous Anonymous said...

WHAT?

7:00 AM  

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